Eliminate Debt At Your Own Pace: 4 Practical Approaches You Can Use
Dealing with debt can be a frustrating experience. One of the best ways to get beyond the frustration and reduce your debt is to make a plan. The right debt reduction plan leads to success at your own pace, and in your own way.
Before you start your debt reduction plan, review your spending and make a budget. The Federal Trade Commission recommends writing down all expenses, "even those that seem insignificant." Once you know where your money is going, figure out where you can cut back, and how much you can put toward your debt reduction plan.
Here are 4 different approaches to reducing your debt:
1. Debt Snowball
The phrase "debt snowball" was popularized by financial guru Dave Ramsey. However, the basic outline for the debt snowball has been around for quite some time. With the debt snowball, you list all of your debts, starting with the smallest amount.
Money designated as debt reduction is applied to the smallest debt, on top of the minimum payment amount. Meanwhile, you continue making minimum payments on other debts. When the first debt is paid off, the entire amount (debt reduction plus minimum payment) is applied to the next debt on the list, on top of its minimum payment. Over time, the debt reduction payments grow, and the debt is retired a little faster.
2. Debt Avalanche
Even though the process for the debt avalanche is the same as that followed in the debt snowball, the order in which debts are paid off is different. Rather than starting with the smallest debt, the debt avalanche encourages you to start with the highest interest debt. A study from the University of Michigan, "Winning the Battle but Losing the War: The Psychology of Debt Management," found that it's more financially effective to tackle the highest-interest debt first -- no matter how large the debt is.
However, the study also found that many consumers are averse to this method and psychologically prefer the quick victory of paying off the smaller debt, even though ordering debts this way, without regard to interest rate, can be more expensive and keep consumers in debt longer.
Debt snow-flaking is more of an addition to the debt snowball or the debt avalanche method. To "snowflake" your debt, you choose either the snowball or the avalanche and follow that plan. Then, to boost debt pay down, you look for ways to add a little more to the plan. "Snowflake" amounts are small and paid as soon as you get them. These amounts can come from cutting something additional out of your budget, or by making extra money with a side job or by selling some of the items sitting in your attic. With snowflakes added to a snowball or avalanche, debt can be retired a little bit faster.
4. Debt Siege
According to a study from Ohio State University published in the January 2013 issue of the journal Economic Inquiry, young people are adding credit card debt at a faster rate than ever -- and they are paying it off more slowly. Many young people appear to be somewhat comfortable carrying a certain amount of debt, and that leads to a debt reduction method known as the siege.
With this method, steps to pay off debt by aggressively cutting back on spending, or snow-flaking with additional income, are not employed. Instead, the debt siege focuses more on comfort and paying off debt in a leisurely manner that doesn't require huge changes to spending behavior. It takes longer (the Ohio State study indicates some of the current generation will be comfortable carrying debt until they die), and more is paid in interest, but it is also a little more bearable -- if you are not as uncomfortable with the idea of carrying debt.
Consider which method is most likely to benefit your psychological situation, as well as your financial situation, and decide which will work best for you.