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When it comes to how to create a debt payoff plan, there are competing theories as to which is the best way to do it. Many subscribe to the “debt snowball method” where you start by paying off your smallest balance first. The other popular method is to pay off the balances with your largest interest rate first.
Which one is right for you?
I took an in-depth look at both debt payoff methods including a couple of examples. But before I get to the results – the most important thing in paying off debt is that you make it a priority! While you are learning how to stay debt-free and pay off your debt, you will fail 100% of the time if you’re not committed.
How to Create a Debt Payoff Plan:
Debt Payoff is a big deal these days. According to this recent study by Nerdwallet, a quick glance at the financial situation of the average American family will explain why:
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- The total credit card debt is $915 billion
- Total auto loan balances are $1.36 trillion
- Total student loan balances are $1.55 trillion
That’s a lot of debt people! But you don’t have to be a contributing statistic to our country’s debt epidemic. Speaking from experience, getting that debt paid off is awesome. The most surefire way to get it done is to HAVE A PLAN.
What Is the Best Debt Payoff Method?
For this debt payoff method comparison, I created a couple of “portfolios” of debt. I also created a gigantic spreadsheet to help me create debt payoff plans using both the debt snowball debt payoff method and the highest interest rate first debt payoff method.
One of the scenarios is somewhat realistic, although that auto loan rate is crazy high (more on that later), while the other scenario is very wacky.
Here’s the first debt portfolio (somewhat realistic):
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- Credit Card – Balance: $2,500, Interest rate: 10.00%
- Student Loan (Public) – Balance: $9,000, Interest rate: 5.00%
- Auto Loan 1 – Balance: $20,000, Interest rate: 7.00%
- Auto Loan 2 – Balance: $8,000, Interest rate: 13.00%
- Sum of minimum payments: $550
- Extra monthly money available for debt: $200
Here’s the second debt portfolio (wacky):
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- Credit Card – Balance: $2,500, Interest rate: 2.00%
- Student Loan (Public) – Balance: $9,000, Interest rate: 11.00%
- Auto Loan 1 – Balance: $20,000, Interest rate: 12.00%
- Auto Loan 2 – Balance: $8,000, Interest rate: 8.00%
- Sum of minimum payments: $550
- Extra monthly money available for debt: $200
Option 1: The Debt Snowball Method
Under the debt snowball debt payoff method, you ignore interest rates and pay off your debts according to the size of the balances, starting with the smallest balance first. Any extra money that you find in your budget goes towards getting that first debt paid off.
Once the first debt is paid off, any money in your budget that was going towards paying off that debt will not be applied to the next debt to be targeted. Continue “snowballing” previous debt payments into the next debt until you have an avalanche of money going towards that final debt to pay it off once and for all. This simplified chart helps illustrate the method. It is assumed that $650 is available each month for debt payments.
I hate to talk math at y’all, but this isn’t too hard, right? I did take the interest rates out of this to make the numbers nice and round… if they were included, the above debt balances would be slightly increasing from month to month. But I hope you get the point.
Pros and cons for the snowball method
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- Pro – total number of debts reduced quickly.
- Pro – small emotional victories can help motivate.
- Pro – easy to follow.
- Con – might take longer to become debt-free.
- Con – you might pay a little more in interest.
Option 2: Largest Interest Rate First Debt Payoff Method
Many personal finance experts recommend paying off the largest interest rate debts first and then tackling the smaller interest rates. The reasoning is fairly simple: the quicker you pay off high-interest debt, the less you will be paying in interest.
Mathematically, this makes perfect sense. You pay less on interest and more on the principal, and your debt gets paid off faster.
Using this method, you should still “snowball” your debts. Once one debt is completely paid off, you take what you were paying on that one and apply it to the next debt in line. Technically, both methods should involve “snowballing”… but when finance nerds say “snowball method”, they are generally referring to paying off small balances first.
Pros and cons for the larger interest rate paid first method
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- Pro – the mathematically quickest way to debt freedom.
- Pro – less interest paid.
- Con – carry a larger number of debts for longer.
- Con – possibly more difficult to manage.
The Comparison in Action!
Portfolio 1
I will first show you just how long it will take to pay off this debt if you didn’t apply any other money except the minimum payments and don’t snowball your payments. In that case, it would take you 9 years, 5 months, and $53,058 to pay off this portfolio of debt.
Using the debt snowball debt payoff method and applying an additional $200 a month on top of the minimum payments, debt portfolio 1 would be paid off as follows:
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- Credit Card – Balance: $2,500, Interest rate: 10.00% – Payoff date: Month 11
- Student Loan (Public) – Balance: $9,000, Interest rate: 5.00% – Payoff date: Month 45
- Auto Loan 1 – Balance: $20,000, Interest rate: 7.00% – Payoff date: Month 64
- Auto Loan 2 – Balance: $8,000, Interest rate: 13.00% – Payoff date: Month 31
- By paying $750 total each month, this total debt of $39,500 will be paid off in less than 5 years, 4 months.
- Total paid: $47,428
Using the highest interest rate first debt payoff method and applying an additional $200 a month on top of the minimum payments, debt portfolio 2 would be paid off as follows:
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- Credit Card – Balance: $2,500, Interest rate: 10.00% – Payoff date: Month 31
- Student Loan (Public) – Balance: $9,000, Interest rate: 5.00% – Payoff date: Month 63
- Auto Loan 1 – Balance: $20,000, Interest rate: 7.00% – Payoff date: Month 56
- Auto Loan 2 – Balance: $8,000, Interest rate: 13.00% – Payoff date: Month 27
- By paying $750 a month, this total debt of $39,500 will be paid off in less than 5 years, 3 months.
- Total paid: $47,055
Using this somewhat realistic debt portfolio, paying off you will save $373 over the course of 5 years, and pay the debt off one month sooner. But take a look at how long you have to wait until even a single debt is paid off – over 2 years!
Is it worth it to tackle the highest interest rates first to get that more mathematically pure debt payoff? It’s up to you. But here’s the thing, it usually makes almost no difference at all. Here’s why – smaller debt balances tend to have higher interest rates anyway. So no matter which method you choose, the order that you pay off debts won’t vary too much. Even in this scenario, I had to create a high balance debt with a super high-interest rate just to show any kind of significant difference between payoff dates.
That said… if your debt balances have super wacky interest rates, then you might want to consider paying off the highest interest rate balances first. Scenario 2 illustrates this.
Portfolio 2
Paying just the minimum payments and not snowballing debts, it would take 11 years, 6 months, and $61,794 to pay off this debt.
Using the debt snowball debt payoff method and applying an additional $200 a month on top of the minimum payments, debt portfolio 2 would be paid off as follows:
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- Credit Card – Balance: $2,500, Interest rate: 2.00% – Payoff date: Month 11
- Student Loan (Public) – Balance: $9,000, Interest rate: 11.00% – Payoff date: Month 47
- Auto Loan 1 – Balance: $20,000, Interest rate: 12.00% – Payoff date: Month 73
- Auto Loan 2 – Balance: $8,000, Interest rate: 8.00% – Payoff date: Month 29
- By paying $750 total each month, this total debt of $39,500 will be paid off in less than 6 years, 1 month.
- Total paid: $54,061
Using the highest interest rate first debt payoff method and applying an additional $200 a month on top of the minimum payments, debt portfolio 2 would be paid off as follows:
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- Credit Card – Balance: $2,500, Interest rate: 2.00% – Payoff date: Month 53
- Student Loan (Public) – Balance: $9,000, Interest rate: 11.00% – Payoff date: Month 70
- Auto Loan 1 – Balance: $20,000, Interest rate: 12.00% – Payoff date: Month 58
- Auto Loan 2 – Balance: $8,000, Interest rate: 8.00% – Payoff date: Month 66
- By paying $750 a month, this total debt of $39,500 will be paid off in less than 5 years, 10 months.
- Total paid: $52,457
The savings in this method are $1,604, and it will be paid off 3 months sooner. Those savings are definitely more significant, but still not as much as you might think. I had to create a ridiculous scenario to get this result where the balances and interest rates are inversely related… although I suppose having 0% on a credit card for a limited period of time is quite common.
The Verdict: What is the most effective way to pay off debt?
The biggest takeaway from this calculation is that either method you choose, you’ve got to snowball your payments! In the first scenario, adding $200 a month and snowballing payments gets you debt-free 4 years sooner and you will pay about $6,000 less in interest. A small amount of extra money each month makes a huge difference in getting this debt paid off.
I’m not going to advocate strongly for either method. Use whichever method will give you the greatest probability for success. If getting those early wins of paying off smaller debts motivates you to keep going, then go with the snowball method (smallest balances first). That’s what worked for me. If the thought of tackling your debt using a more mathematically pure method motivates you, then use the high-interest rate first method.
Whichever method you choose, “snowballing” those debts is a must. When you’re in ‘get out of debt’ mode, just throw everything you have at it, be patient, persistent, and watch your debts melt away.
How do I Set Up a Plan to Pay Off Debt?
Interested in your own personal debt payoff plan? I’ve got something that can do just that!
Let me guess… you’re interested in me sending you the spreadsheet so you can create your own debt payoff plan? Trust me… you don’t want it. It’s kind of a mess. But I’ll go one step better and provide you access to a tool that will give you your own personalized debt payoff plan!
Can I Set Up a Debt Management Plan Myself?
I firmly believe you can do anything you set your mind to with a plan and disciplined commitment. It can be challenging to change habits and mindset, especially when it comes to money patterns and behavior. I created my signature Flip Your Debt course which guides you step by step to financial freedom.
The course is unique from just a simple spreadsheet with your debts and some dates scattered across it. We dig into the emotions you hold around money so you can create lasting results with your finances. In other words, get out of debt and stay out! And you’ll receive a supportive community of those with similar goals so you can encourage one another in achieving your desire to be debt-free, and celebrating each milestone along the way!
Summary:
You already know being saddled in debt isn’t helping you live the life you imagined. There is hope to get out from under the weight of debt and step into a life of financial freedom.
- Start by figuring out how much debt you have, the interest rates, and the minimum payment amounts
- Decide your monthly income, and also note additional monthly expenses
- Determine how much extra money you can put towards your debt payoff goal. Remember any little extra helps!
- As much as possible, trim your monthly expenses. I have lots of ideas on my blog for things like saving on your groceries, saving on your cable, and more.
- Can you make any additional income each month? There are side hustles and money-making apps to help you out. Remember your goal is paying off your debt.
- You may choose a debt payoff method like the Debt Snowball or the Higher-Interest Rate First. There are other strategies out there too. The point is to choose one and be committed.
- Once one debt is paid off, use that monthly payment amount and put it towards the next debt in line. Remember this takes discipline.
- A course like my Flip Your Debt can help you with the emotions around debt and financial freedom by giving you step-by-step support and an encouraging community of like-minded women.
You may also like:
How to Get a Clear Vision of Your Finances
How Using a Financial Bucket List Can Help You Get Out of Debt
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