Winter is Coming

    Two Strategies to Slay Your Debt

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    The average American family owes $8,377 in credit card debt according to a May 2017 article from CNBC’s MarketWatch. While a third of borrowers pay off their credit card bills in full each month, two-thirds of borrowers are carrying some kind of balance. In fact, Americans are loaded with debt, including mortgages, car loans, student loans, and even personal loans.

    It doesn’t have to be this way. If your family is struggling with debt, there are a number of strategies you can use to pay it down. Let’s look at two popular debt repayment approaches: the “snowball” and the “avalanche.” Both programs have benefits and drawbacks. After reading this, you will be able to figure out which debt repayment program would best suit you. We’ll also talk about scenarios where it may not be in your best interest to pay down your debt as fast as possible.

    The Snowball

    Using the snowball strategy, you start by focusing on paying off your smallest debts (in terms of dollars) while you make the minimum payment on your other debts. Every time you pay off a small debt, you roll that entire payment you were making on your smallest debt to your next smallest debt.

    Why does this work for some people? There is a real satisfaction that comes from achieving a goal. The beauty of the snowball debt repayment program is the mental boost you get along the way from paying down those small debts. It helps build momentum as you push through to your ultimate goal of paying off your debts.

    The Avalanche

    The avalanche is a debt repayment strategy that focuses on minimizing the interest cost as you pay down your debt. After you make the minimum payments on your debt, you focus all of your remaining cash on your debt with the highest interest rate. After you pay off your debt with the highest interest rate, you roll all that money to the debt with the second highest interest rate and so on down the line.

    With the avalanche method, you save money, but you may not pay off your first debt as quickly as you would with the snowball method. This means you may not get that mental boost of paying off your debt as quickly.

    Things to Remember as You Tackle Your Debt

    Paying off your debt is a worthy goal, but it may not be your only goal. Don’t be in such a rush that you miss out on powerful opportunities. For example, be careful about passing up company matches on 401(k) plans in the name of living debt-free, or passing up on legitimate opportunities to move your career forward (such as attending a networking event) in the name of cutting costs.

    Be wary of being overzealous. While being debt-free is certainly a great goal, don’t completely sacrifice your finances on the altar of debt repayment. Extreme measures to pay down debt, such as borrowing from your 401(k), can lead to hidden costs, such as a lack of career flexibility or mistakes in making loan payments that result in your loan turning into a taxable withdrawal.

    Like any lifestyle change, debt repayment should be treated as a lifestyle shift, not a yo-yo diet. If you are overly restrictive with your spending, that new spending pattern can be very hard to maintain and may lead to excessive splurges. Sort of like that time you ate two hard-boiled eggs and half an avocado for breakfast (thanks Instagram), a salad for lunch, and then a giant piece of carrot cake at four in the afternoon because you were starving.  Not a good feeling. Well, to be clear, the cake was amazing – it was the guilt you could skip.

    Rationally, the avalanche method will generally save you more money in interest payments. There’s just one tiny problem. We sometimes make cognitive mistakes when making decisions, particularly around money. Sometimes, that means we are overly optimistic, overly fearful, or we expect the past to repeat itself.

    It turns out that money is a highly emotional topic. Studies by University of Michigan and Boston School of Business have shown that people do a better job of paying down debt when they get those little wins along the way (as in the snowball method). The momentum can help you continue on what can be a long journey. Ultimately, successfully paying off your debts is the most important part of this equation. Generally, this means starting with smaller debts and focusing on one debt at a time. However, if limiting your interest costs is highly motivating to you, then by all means, use the avalanche method.

    And another thing: If you are really struggling with debt, it may be time to seek out assistance from a non-profit credit counseling service. This is not the same thing as a business claiming to improve your credit scores. The Federal Trade Commission (FTC) has a resource on its website called “Choosing a Credit Counselor” that can help you understand the questions you need to ask organizations as you start your debt repayment journey.

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    Lauren Zangardi Haynes
    Lauren Zangardi Haynes CFP(R), CIMA is a fee-only financial planner with Evolution Advisers in Midlothian. She has three kids (ages seven and under) and an elderly miniature schnauzer. Lauren is also the founder of a personal finance blog for families with kids at home called Words on Wealth.