The Best Way To Pay Off Debt Fast

Debt has been described as a menace, as a virus, as a destructive force of evil and indeed it can be all of these things, if you let it.

Debt can also be used in certain ways to your advantage, however these methods are only for the most disciplined.

You have to be honest with yourself here, if you are likely to ‘miss-use’ debt if it is available to you, you are better off paying off all your debt and having none available at all.

But how exactly do you pay off debts. It can be really hard, especially if you are struggling financially.

Dealing With Debt

The first step to get out of debt is simply to build an understanding of how much you owe, to who you owe it and on what terms.

I suggest you make a list of all of your debts in a little table now.  

On your list, you should record:

• A total for how much you owe on each debt.
• The interest rate you are currently paying.
• The end date of the interest rate if you are on a special or limited time interest rate. This is common for mortgages and credit cards.
• The minimum payment you HAVE to pay each month.
• The monthly payment you are currently making.
• The term of the debt, if it has one. Mortgages for example, usually have a total term (25 years), where as some debts, like credit cards are open ended.

If you are missing any of the above information, take some time to add it into your table now – it will be vital for this exercise.

When it comes to clearing down and repaying debts, there are 2 strategies that I recommend. Which of them will suit you will depend mainly on your personality type, but we are going to consider both in detail in just a moment.

Before we look at debt repayment though, there are a couple of things to do first…

Debt Re-negotiation

Many people have debts on credit cards and overdrafts which carry very high rates of interest.

It is often possible to re-negotiate the debt in order to secure a better interest rate, either for a fixed period of time, or for the whole time it takes you to pay off the balance.

For example, many people carry debts on credit cards with interest rates between 15% and 30%.

There are usually a whole load of so called ‘balance transfer’ deals available from other credit card providers.

Lets say you have a credit card balance of $5,000 with provider A and it has an interest rate of 19.9%.

A balance transfer means that you transfer the balance on your credit card with provider A to a new credit card with provider B.

Provider B is keen to win your business, so may offer all kinds of deals to attract you like interest free balance transfers for 15 months or a low interest rate of say 3.9% for as long as it takes you to repay the balance.

This is clearly better than paying 19.9%.

The same can be said for loans, credit cards and overdrafts.

You should always check to see if you can secure a lower interest rate with either your current provider or a new provider.

So many people have debts on deals that are simply not competitive – it’s always worth seeing if you can do better.

Once you have looked into re-negotiating debts, you can also consider…

Debt Consolidation

The other way to really reduce the interest rates on your debts it to think about consolidation. 

Imagine you have a balance on a credit card, an overdraft and a finance agreement for a new car you bought, all with fairly high rates of interest. 

If you have a good relationship with your bank, it may be possible to get a personal loan to repay all of your debts at a much lower interest rate.

Personal loans are available from around 3% interest rate nowadays, which is much cheaper than most overdrafts and credit cards.

Ok – Back to our Repayment Plan

Now that you have re-negotiated or consolidated your debts if possible, we can start to think about how to clear those pesky debts once and for all.

Before we look at debt repayment though, there is an assumption that you have some spare income each month to use for debt repayment. 

If you are regularly adding to your debts on a monthly basis and you don’t feel like you can get this under control (or even worse you are using one debt to make payments on another), then you may need to seek some professional debt help.

There are loads of organisations that can help you if you are in serious debt trouble.  

Assuming you do have at least some spare income each month (even if this means cutting back for a little while) then read on. 

There are 2 main methods of debt repayment. Let’s look at them in turn:

The Debt Snowball

With the Debt Snowball, you put all of your debts on a list, starting with the smallest debt first, followed by the next smallest and so on.

Let’s use an example to make this clearer.

You can see here, that Credit Card 1 has the smallest outstanding balance so that goes at the top of the list, followed by the overdraft and so on.

Credit Card 2 is last on the list as it has the biggest balance.

The theory behind the Debt Snowball is that you focus all available monthly budget on paying off the smallest balance first.

This even means that we divert money away from other debts in order to focus on the smallest.

Of course you will still need to pay the minimum payments on all of your other debts, but that should be all.

Looking at the list in turn, you can see that on Credit Card 1, the minimum payment is $50 and you are currently paying $50. As such, there is no spare budget here.

On the overdraft however, there is no minimum payment, but a payment of $150 per month is being made. With the Debt Snowball, we would stop making this payment completely (because we don’t have to) and divert the whole $150 per month to pay off the smallest balance, which is Credit Card 1. 

The car loan has a required payment of $300 per month and that is what is being paid, so we can move on.

Finally, credit card 2 has a minimum payment of $150, but $300 is actually being paid. Again, we would divert the $150 per month ‘extra’ payment here and start to pay it off Credit Card 1.

This means we have the original $50 (that we were paying on Credit Card 1 anyway), an extra $150 taken from the overdraft and $150 from Credit Card 2, giving a total monthly payment to Credit Card 1 of $350.

Your table would now look like this: 

Now that we have a nice healthy payment of $350 being chipped off of Credit Card 1 each month, the total balance would be re-paid in just over 3 months – pretty good progress.

At this stage, we would divert our attention to the next smallest debt, being the overdraft. There is no minimum payment on the overdraft, so we would take the full $350 per month we were paying off from Credit Card 1 and pay this off the overdraft. 

The table would now look like this:

At the rate of $350 p/m, the overdraft should take a little over 7 months to repay. This means after 10 short months, the 2 smallest debts have been totally repaid.

Once the overdraft is gone, we divert all of the $350 to the car loan. The payment on the car is already $300 per month, so we add the $350 to this and make a total payment of $650.

Your table is now:

At the rate of $650 per month, you can clear that car loan in as little as 15 months – less than half the 3 year term!

Finally, once the car loan is gone, we divert all remaining budget to Credit Card 2 as follows:

At $800 per month, Credit Card 2 will be gone in around 16 months.

So there we have it, the Debt Snowball in full effect.

The other option we have available is…

The Debt Avalanche

The Debt Avalanche is similar to the Debt Snowball, with one vital difference. With the Debt Avalanche we focus our attention on the interest rate being paid on the debt, rather than on the size of the balance.

With the Debt Avalanche, you would put all of your debts in order based on the interest rate you are paying, with the highest interest rate first.

Using the examples from previously, your debt table would now look like this:

Notice how Credit Card 2 goes at the top of the list, as it has the highest interest rate, followed by the Overdraft with the next highest and so on. 

The strategy here is similar to the Debt Snowball, but instead of focusing all of our available budget on the smallest debt, we focus on the one with the highest interest rate.

So in this example, we would continue to pay the $300 per month that is already being paid on Credit Card 2. We would also stop making the overdraft payment for now and divert that $150 to Credit Card 2, making a total payment of $450 per month.

Your table now looks like this:

At this rate, Credit Card 2 is likely to take around 22 months to pay off. Notice how with the Debt Avalanche, we potentially have to wait quite a lot longer to see real progress (with the Debt Snowball, we paid off the first balance in just 3 months).

Credit Card 2 now gone, we would focus on the debt with the next highest interest rate:

Then we move onto Credit Card 1:

And finally, the Car Loan:

So there you have the Debt Avalanche. But you might be asking yourself the question…

So, Which Is Better?

When asking if the Debt Snowball or the Debt Avalanche is ‘better’, the answer, as with many things in life is – it depends.

In the strictest possible sense, the Debt Avalanche is the most ‘logical’ option. If you are looking only at the dollars and cents of matters, the Debt Avalanche will come out on top.

The reason for this is that you are paying off the high interest debts first, meaning that you pay slightly less in interest overall as you go through your debt repayment journey.

The Debt Snowball on the other hand, delivers the quickest ‘win’ on the basis that you pay the smallest balance off first.

The repayment of that first small debt gives a psychological boost (it feels great to be making progress), which then spurs people on to pay off the next debt and so on.

With the Debt Avalanche, although you are technically being slightly more ‘sensible’, you often have a long-hard wait to get that first victory.

My advice is this:

Unless you really are super disciplined (and, let’s be honest, if you are in this debt in this first place, can you honestly say you are that disciplined? Sorry to be harsh, but we have to tell the truth), I would suggest that you go with the Debt Snowball.

My experience is that people actually have far more success with the Debt Snowball because of that early psychological victory.

When you look at the psychology of motivation and goal setting, it is almost universally agreed that we should break big goals down into the smallest possible steps and look to celebrate small wins along the way to boost our motivation.

Yes, you may well pay a little bit more interest paying debts off this way (but we are often only talking a few dollars) and, let’s be honest, the goal here is to get rid of that nasty debt, not just to optimise every penny we spend.

The Best Of Both Worlds

Having just looked at the difference between the Debt Snowball and the Debt Avalanche, could it actually be that you can have the best of both worlds?

Well, in many cases the answer is yes, or very nearly yes. Let me explain.

You see, smaller debts tend to have the largest interest rates. If you think about it, this does sort of make sense.

We tend to carry smaller balances on things like overdrafts and credit cards, that often have high interest rates. We also tend to carry larger balances on things like car loans and mortgages that have smaller interest rates.

As such, a real-world debt repayment table might actually look like this:

In this case you can have the Debt Snowball rolled (sorry) into the Debt Avalanche as the balances and interest rates happen to fall into place (the smallest balance has the highest interest rate and so on).

Based on the fact that smaller debts tend to have bigger interest rates, it is very likely that you can reach this ‘best of both’ situation with your own debt repayment strategy or if not, you can probably get pretty close. Let me show you with one final example:

 In this case, the credit card has the higher balance vs the overdraft, but also has a slightly higher interest rate.

In this case, although the rules of the Debt Avalanche would say put the credit card first, I would actually pay the overdraft off before.

Although the overdraft has a slightly smaller interest rate, the extra cost of paying this off first instead of the credit card (19.9% vs 21.9%) is so minimal, I would rather have the motivation boost of getting that overdraft cleared fast.

So does all of this mean that you should clear all of your debts and have no debts at all?

Well, as with most things, not all debt is bad.

Good Debts?

There are some forms of debt that are neutral and even some types of debt that are really good.

If used sensibly debt can actually enhance your financial position and get you closer to financial freedom.

Using 'good debt' in this way is only for the most disciplined of people. You can head on over to this post if you want to learn more about the different types of good debts.