top of page

A Financial Coaching Blog

Send us an email at blog@monthlyfinancialcoaching.com if you have a topic you would like discussed.

Writer's pictureTreavor Dodsworth CFP®, CPA, CKA®

DEBT PAYOFF STRATEGIES

There are two primary ways that people pay down debt. Attacking the debt with the smallest balance or attacking the debt with the highest interest rate.


Borrower is slave to the lender

Before I explain these I want to give a general thought process or framework for debt. I believe you should have a healthy dislike for debt. While I don't think a reasonable mortgage or student loans (if pursuing some sort of forgiveness) are unhealthy, most other forms of debt - credit card, auto loan, etc. should be avoided.


Two primary debt payoff strategies:

  1. Snowball - This strategy is more about human psychology and involves attacking the debt with the smallest balance owed first. For example, if you have a $10K credit card with a 25% interest rate and a $4K car loan with a 5% interest rate under this strategy you would pay off the car loan first and then move to the credit card. You would then take your regular excess plus the amount you were paying on the car loan to then attack the credit card. This strategy allows the number of loans to disappear more quickly but may result in paying more in interest than the next method.

  2. Avalanche - This is my personal preference and the one the math generally supports. In this strategy you attack the debt with the highest rate and then second highest rate and so on. Under this strategy you would pay off the credit card first and then the auto loan (assuming the above numbers).


I have also heard of people intentionally attacking the debt with the lowest interest rate first. I think this may be because of a false understanding of how debt works and is generally not recommended. This doesn't mean you won't pay off debt with low rates or even a 0% rate but you are just not specifically prioritizing debt because it has a low rate.


In reality, you will likely use some combination of Snowball and Avalanche when paying down debt. For example, let's assume the following $300K mortgage at 6%, $15K credit card at 25%, $10K auto loan at 5%, and $1K medical loan at 2%. You may choose to just knock out the medical loan since the balance is so small (snowball method) and then move to the credit card because of the high rate (avalanche method) and then move to the auto loan since the balance is so much less than the mortgage and the rates are close (snowball method).


Regardless of what method you choose, having a plan for paying off and staying out of debt (particularly consumer debt) is paramount and can free up margin to spend on the other uses of money.

Comentários


All written content on this website is for information purposes only. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. The owner of this website takes great care to thoroughly research the information provided to ensure that it is accurate and current. Nonetheless, the content on this website is not intended to provide tax, legal, accounting, financial, or professional advice, and readers are advised to seek out qualified professionals that provide advice on these issues. All information or ideas provided should be discussed in detail with an advisor, accountant, legal counsel, and/or other pertinent professionals prior to implementation. In addition, the owner cannot guarantee that the information on this website has not been outdated or otherwise rendered incorrect by subsequent new research, legislation, or other changes in law or binding guidance. Neither Monthly Financial Coaching or it's owner shall have any liability or responsibility to any individual or entity with respect to losses or damages caused or alleged to be caused, directly or indirectly, by the information contained on this website. In addition, any advice, articles, or commentary included on this website do not constitute a tax opinion and are not intended or written to be used, nor can they be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer. Any mention of an investment product or solution is not a recommendation to buy or sell. Past performance is not a guarantee of future results. Any mention of rates or return should not be seen as a guarantee those rates or return will be received.

bottom of page