Shop 02 128Pay Off Debts

Why should I pay off my debt?

Paying off debt should always be a high priority unless your interest rates are very low because interest accrues on a regular basis and the longer you wait to pay off debt the more you will need to pay.

How should I pay off my debt?

You should always pay the minimums on all of your debt. Past that there two methods to pay off your debt:

  • Avalanche - With this method you pay off your highest interest loans first. Using this method is the most financially optimal way to pay off your debts because your high interest loans are costing you the most money as interest.
  • Snowball - With this method you pay off your smallest balance loans first. This method could be a good way to give you a psychological boost because you feel like you are making progress by completely paying off loans faster but you end up paying more money because your high interest loans are left unpaid longer. This can also improve cash flow because you no longer have to meet as many minimum payments.

Example

  • Loan A: $1000, $100/mo min payment, 5% interest rate
  • Loan B: $5000, $500/mo min payment, 10% interest rate
  • You have $3000 to pay off loans

First, you would need to pay $100 and $500 ($600 total) to meet the minimum payments of each loan. With the avalanche method you would put the left over $2400 into Loan B because it has higher interest. With the snowball method you would completely pay off Loan A with $900 and then put the remaining $1500 into Loan B.

Overall, the avalance method will allow you to pay the least amount of interest but the snowball method can be useful to reduce your minimum payments or to give yourself a psychological boost.

How can I reduce my debt or reduce my interest rates?

Here are a few things you can try to reduce your debt:

  • Negotiate the amount you need to pay

    We recommend trying to negotiate with the lender to see if they will lower your debt balance if you agree to pay the full amount quickly. This tends to works with medical debts but can also work for other debt.

  • Negotiate your interest rates

    You can try to call your credit card company and see if they will lower your interest rate. This is especially effective if you have a great credit score, have a history of paying off your balances on time or have a credit card offer from a competing company that comes with a lower interest rate that you can use to negotiate with.

  • Refinance/Transfer Debt

    You can also reduce your debt by refinancing, meaning taking on a new loan with a lower interest rate to reduce or eliminate your original debt. You can transfer your credit card debt to another card that offers 0% intro APR. Depending on the card, you may need to pay a fee to do a balance transfer but it can be definitely worth it to do so if it means you stop paying high interest on your existing debt. You can also try to find lower rate loans from your bank, use P2P lending companies such as LendingClub and Prosper or getting a HELOC on your house. You can also refinance student loans from 3rd party lenders such as CommonBond.

  • You can sometimes get a lower interest rate if you setup automatic payments on your student loans.

Just remember to use these methods only to pay off existing debt and not as tools for taking on more debt!

Should I invest or pay off my debt past the minimums?

Paying off debts should be a high priority use of your money. Debts that have an interest rate greater than 4%, such as credit card debt, should be paid off before putting money into investments because debt has a guaranteed return equal to your debt's interest rate. Though long term investments return about 7% a year on average they can definitely be lower than 4% or even negative in some years. One exception is if you have 401(k) matching (or matching on any retirement plan) from your employer because your return from this is almost certainly greater than the interest rate on your debt.


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