Two Effective Strategies for Dealing with Your Debt

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Two Effective Strategies for Dealing with Your Debt

Do you want to pay off your debt?

If so, here are two strategies you should know.

“Debt stacking” and “debt snowball” are two different tactics that can help you pay down your debt. One method focuses on math, while the other focuses on emotion and psychology.

Depending on how you handle your finances, you might find that one of the two fits you better than the other. Choose whichever method works best for you — after all, it’s called “personal” finance for a reason.

How do you decide if which method is right for you? Learn how they both work.

Let’s the take the example of a recent college graduate who has five different debt sources:

#1. Student Loan – $2,000 plus 5 percent interest

#2. Mastercard – $5,000 plus 13 percent interest

#3. Visa – $2,500 plus 7 percent interest

#4. Car Loan – $6,000 plus 15 percent interest

#5. Outstanding Medical Bill – $1,500, interest-free

Watch the different ways the debt snowball method handles paying off the debt as opposed to debt stacking.

Debt Snowball

Best For: Those who want to cut down on different debt sources.

The debt snowball method advocates paying off the smallest debt first, regardless of the interest rate. First, the borrower organizes all of their debt into a list from lowest to high. In this case, the list would be:

#1. Outstanding Medical Bill – $1,500

#2. Student Loan – $2,000 plus 5 percent interest

#3. Visa – $2,500 plus 7 percent interest

#4. Mastercard – $5,000 plus 13 percent interest

#5. Car Loan – $6,000 plus 15 percent interest

The borrower makes the minimum monthly payments on all five debt sources. Extra money then goes to paying off the $1,500 medical bill. Once that gets paid, the borrower moves on to paying off the $2,000 owed on student loans.

It’s a very successful method for those who want to feel like they are making some headway in their debt. In very little time, a person would cut five different debt sources into just three sources.

However, because this method focuses just on lowest amount owed, it does not take interest rates into account. The downside is that by prolonging a debt with the highest interest rate, the borrower ends up paying more in interest in the long term.

Debt Stacking

Best For: Those who want to avoid high interest payments.

The debt stacking method adovcates paying off debt sources with the highest interest rates first. The borrower needs to make a list of all their debt starting with the highest rate and ending with the lowest. In this case, the list would look like:

#1. Car Loan – $6,000 plus 15 percent interest

#2. Mastercard – $5,000 plus 13 percent interest

#3. Visa – $2,500 plus 7 percent interest

#4. Student Loan – $2,000 plus 5 percent interest

#5. Outstanding Medical Bill – $1,500

The borrower first pays off the minimum balance on all their debt. Then, it’s time to use the extra money to start chipping away at the biggest interest rate, in this case the 15 percent rate that comes from the car loan. It might take some time to pay off all $6,000, and once the borrower gets done it’s time to move on towards the Mastercard with its 13 percent interest.

This tactic works best for those who want to avoid high interest rate, which in turn add up to higher payments over a longer period of time. By working off the debt with the highest rate first, the borrower is saving money compared to someone using the Debt Snowball tactic. The downside is that it takes some time to pay off $6,000, and borrowers get discouraged. At some point, it might seem more practical to start making extra payments to the student loan or the outstanding medical bill instead of chipping away at the car loan.

Which one should you pick? Whichever one works best for you. The most important thing is that you pay down your debt, regardless of which tactic you use.

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MARCH 23RD 2020

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