Attacking Your Debt: What’s the Best Approach?
You may know the feeling: You’re at the bookstore and spy a wonderful new reference book that’ll help with your art….or you’re at the clothing store to pick out an outfit for an audition, and the perfect fit is just outside of your price range.
What’s a little credit card debt, right? You’ll be able to pay it off later. Hopefully.
Whether you took on debt by overspending on your craft, or your job doesn’t pay enough, debt is a weight that’s hard to relieve. That said, getting rid of debt is the first step when creating the Abundance Bound mentality. According to financial site NerdWallet, the average household in the U.S. carries $15,422 in debt. Ouch. More meaningful is the fact that once people have debt, they’re likely to use credit more and more often. The flip side? 53.3% of the American population carries no debt at all.
We can’t solve the American debt problem, but we certainly can help add you to the 53% without debt, can’t we? How should you pay it down?
Much has been made in the financial press lately about how you should attack your debt. Researchers recently concluded that often what people think of as the smartest option hasn’t been the most effective way to pay down debt. Let’s look at two popular methods and review why you might want to choose the sub-optimal method to pay down your debt.
The Mathematically Sound Method To Pay Debt
If you want to take the fastest path to debt relief, and can stay on it, here’s the obvious solution:
– List all of your debt in order of interest rate.
– Eliminate the debt with the highest interest rate first and work down.
– As you pay off a debt, add the payment amount to the sum you’re using to pay down the next-highest interest rate loan.
That’s it. Interest, when it works for you, is a wonderful component of financial abundance. But when it’s applied against you, debt is a friction that you won’t soon be able to alleviate.
The Sub-Optimal But More Often Effective Method
– List all of your debts according to balance.
– Begin with the smallest balance and work up toward larger balances.
– As soon as you pay off a loan, apply the amount of the paid debt’s payment to the sum you’re putting toward the next-smallest loan.
This method, popularized by financial guru Dave Ramsey, is often referred to as the “Snowball Method.” Every time you pay off a debt, you add that payment amount to the sum you’re applying toward the next card, so like a snowball, you’re picking up steam as you handle bigger and bigger debts.
Why Does It Work?
However, recent research has shown that the reason you’re more likely to pay down debt using this method isn’t because of the actual snowball. It’s because people perform better when they experience small wins along the way. People will stay on track if they have some wins.
This isn’t only true for debt. Video game manufacturers in recent years have added “achievements” to games, which are small awards players win as they tackle milestones during the game. This helps players continue to stick with the game over time. It seems that small wins help us along the path.
Do We Need to Follow a Sub-Optimal Path To Debt Relief?
If you need wins along the route, the debt snowball is a fine method. Sure, you’ll pay more in interest, but you’re more likely to pay down the debt.
Here are a couple other ways to pay down debt more optimally:
– Use free online resources such as Payoff.com or ReadyForZero. These sites turn debt relief into a visual experience and add milestones along your path to debt relief. (downside: if you don’t log into the site or pay attention to the alerts, you won’t pay down your debt quickly.)
– Reward yourself at milestones along the path. Instead of relying on the “wins” associated with paying off little credit cards, how about treating yourself to something nice when you reach 20%, 40%, 60% and 80% paid? Keep a log of your progress to make sure you keep your reward. (downside: you’ll spend extra money on these treats, which will slow down your debt repayment.)
– Use habit forming tools such as Lift (iPhone and Android app) to check in every day that you’ve stuck to your debt repayment strategy. After 30 days you should have a new habit: getting out of debt.
– Read voraciously about ways to save money. Frugal blogs on the internet, books, your favorite websites (like AbundanceBound!) will help you. Remember: you are what you think about!
No matter which method you use to tackle debt, here are the important points:
– Adopt a cash lifestyle today. Put away the credit cards and stop using someone else’s money to fund your goals. This creates nightmares, not dreams.
– Begin your debt repayment strategy now and stick to it.
– If you fall off the wagon, jump back on. Beating yourself up won’t help as much as continuing to build good habits each day.
Go pay down some debt! Once you’re over that hurdle, the freedom you’ll feel will allow you to travel much faster along the road to all your dreams.