Debt can be a scary word for many of us, especially if we’re concerned about our overall financial future. Managing debt is important, but let’s remember, not all debt is necessarily bad. When you pay your home mortgage, you build equity in your home and wealth for the future. A reasonable car payment helps you get to and from work, and a low-interest loan may help you start a business.
These tools are called installment debts, which means their payment amounts and interest rates are set up front. Payments won’t change, and there’s an end in sight, or a pay-off date. Credit cards, however, are considered revolving debt. Payments and balances can shift depending on use, fluctuating interest rates, and your ability to repay the debt.
While credit cards are important to have, if uncontrolled, they can wreak havoc on your overall finances and make you feel like you’re spinning your wheels. If credit card debt is an issue for you, there are a number of strategies you can use to get your situation under control. Let’s look at how you can get out of that negative debt cycle and onto a path of prosperity.
“Snowball,” “Avalanche,” the word soup of debt elimination
Like most of us, you probably have several credit cards, and you may have balances on more than one. So, which do you tackle first? Here are three common strategies we hear of today:
- Pay off the highest interest debt first, sometimes called the “Avalanche” method
- Spread out payments across all the cards equally
- Referred to as the “Snowball” approach, tackle the smallest balance first, regardless of interest rate; then pay the next smallest balance until all are paid off
With the Snowball and Avalanche approaches you start by covering your minimum balance on all of your cards, then choose which one you want to pay more towards. When you spread out your payments, you simply take all that you have set aside for debt elimination and equally distribute it across all cards. Hopefully, you can afford to pay more than the minimum payment on all of them.
Pros and cons
Pitched by financial guru, Dave Ramsey, the Snowball method has become a popular. The Harvard Business Review even studied 6,000 people paying down debt and found that those who used the Snowball approach paid down more debt than those who spread out payments equally. Like crossing off items on a task list, people find it more gratifying to see chunks of debt eliminated. It motivates them to reach the next goal and stick with the process.
The down side, however, is that if you have a $1,000 balance with 15% interest and a $5,000 balance with a 20% interest rate, you’ll pay more in interest, overall. The Avalanche strategy actually saves you money by minimizing interest.
But on the other hand, if paying off a large bill with high interest feels daunting to you, the Avalanche approach may be difficult to stick to. These three popular approaches are not the only ones out there either. So, let’s dig a little deeper to see how we can create the right debt elimination plan for you.
Step 1: Assess (find the money)
Before you can create a strategy, you’ll need to analyze your spending first. Look at your bank and credit card statements for the past two months. Chances are you’ll immediately spot unnecessary purchases and ways you can save money. That morning coffee splurge, eating out with friends, entertainment, they’re some of the easiest expenses to cut first. Allocate what you trim towards your credit card debt.
Don’t worry about choosing your debt elimination strategy yet. You want to get a realistic sense of what you can pay towards your debt elimination goals. If you’re also growing your emergency and retirement savings, good for you! Make it a hard rule to not pull from those allocations, if possible.
Step 2: Negotiate
Most of us don’t know it, but just about everything in life is negotiable – even your credit card interest rate. Call your credit card companies to see if they can reduce your rate. You may opt to transfer balances to a credit card with a 12 or 18-month zero percent promotion. That can work, but ask about the fees associated with the offer. Those fees can sometimes be waived, too. It doesn’t hurt to ask.
Check with your banking partner, too. A low-interest debt elimination loan that consolidates all of your credit card balances into one convenient payment may ease your stress. And if you feel overwhelmed by all the options, ask your bank for guidance. You may need a credit counselor to help. They can also negotiate with your creditors on your behalf. No matter how big your debt may feel, you do have options.
Step 3: Execute (and Enjoy)
Whether you choose a debt consolidation loan, the Avalanche, Snowball, or another approach to eliminating debt, put a plan in place and stick to it. Set goals you know you can achieve. As you eliminate credit card debt, you can focus on paying off a car or student loan next, or even adding more to savings.
Debt elimination doesn’t need to be all work and no play. As you hit milestones, reward yourself – sensibly. It may not be time to book that Hawaii trip yet, but go ahead and enjoy that latte once in a while. With your debt more under control, it’ll taste even sweeter!
At Red Rocks Credit Union, we’re here to help you reach your financial goals. If you would like to learn more about our savings and debt elimination products, please give us a call at 303.471.7625.