Summary: Get Out of Debt by Using a Proven Strategy
The path to a professional career can be incredibly rewarding, but it can also come at a tremendous cost. The ever-increasing cost of a university degree (or multiple!), potentially living away from home, the inability to work due to academic commitments, and the occasional night out can leave a young professional feeling overwhelmed, buried under a mountain of debt before they even earn their first paycheque. Although digging your way out of debt doesn’t have to feel like an insurmountable task, it does require a strategy.
Create a Repayment Plan & Implement a Strategy
Regardless of the debt repayment strategy you choose, it will necessitate an income surplus beyond your discretionary and non-discretionary expenses. Start by clarifying your monthly net income and subtract your expenses. The amount remaining is how much surplus you have available to dedicate towards debt repayment, assuming that is your sole objective.
To determine how best to approach your repayment strategy, you’ll need to get clear on your various debt obligations. Start a spreadsheet including the following information for each of your debts:
- Balance outstanding
- Interest rate
- Minimum payment
- Term (if applicable)
Now that you know how much surplus you have available for debt repayment and a clear understanding of what you owe and the terms applicable to each debt, you can begin to devise a strategy.
Effective Strategies to Tackle Your Debt
Two of the most common debt repayment strategies are the avalanche method and the snowball method, both of which can be very effective in prioritizing which debt to tackle first. The strategy that resonates most with you will depend on your unique situation. Let’s take a look at each method using the following debt profile as an example:
- $12,000 credit card at 19.99%
- $50,000 student loan at 4%
- $6,000 car loan at 6%
Debt Avalanche Method:
- The primary focus of the avalanche method is to pay off the highest interest debt first while making minimum payments on all other debts in the meantime. Therefore, with this method you would make minimum payments on your student loan and car loan, while utilizing the remaining amount to pay down your credit card with it carrying the highest interest rate. Once the credit card is paid off, you would move on to the car loan, and then finish with the student loan.
- The advantage of the avalanche method is that you will pay the least amount of interest compared to the snowball method, by tackling the highest interest debt first. If you have some obligations that carry a significantly higher interest rate than others, this method may be most appropriate.
Debt Snowball Method:
- The primary focus of the snowball method is to pay off the smallest debt first, regardless of interest rate, while making minimum payments on all other debts in the meantime. With this method, you would make minimum payments on the credit card and student loan, while contributing all remaining surplus to paying down the car loan. Once the car loan is paid off, you would move on to the credit card, and then finish with the student loan.
- The advantage of the snowball method is that you start to see progress quickly, which can lead to increased confidence, sustaining motivation as you move on to larger debts. If all of your debts carry relatively similar interest rates, the snowball method may be a great option.
While the avalanche method and snowball method are two commonly used stragies that are available to everyone, there are other strategies that can reduce the amount of interest paid while simplifying the repayment process. However, these strategies may not be available or suitable for everyone:
Debt Consolidation Method:
- This strategy simply involves applying for a loan to consolidate all of your debts into one, ideally with a lower interest rate than would otherwise be paid overall by way of either the avalanche or snowball method. In addition to less interest paid, the advantage of consolidation is that you only have one debt payment as opposed to numerous, making it easier to focus on repayment by not having to prioritize.
- The consolidation method sounds so simple, so why wouldn’t everyone use it? Even with a strong credit rating, a lender may not feel comfortable offering a consolidation loan of sufficient size to cover your outstanding debts. Further, they may not accept the risk of having all of your debts consolidated into their loan, resulting in your existing credit becoming readily available to you for further debt accumulation.
- Provided you are able to qualify for a loan sufficient to incorporate all of your outstanding debts, the interest rate on the loan makes sense compared to what you would pay otherwise, and you are confident you will not continue to accumulate further debt once your debts are rolled into the consolidation loan, this approach can be an excellent option.
Mortgage Roll-In Method:
- If you are planning to purchase a home or condo and are able to qualify for a mortgage under reasonable terms, this option can significantly reduce the amount of interest you will pay as well as simplify the repayment process as long as your outstanding debt balances fit within you lender’s required loan-to-value ratio.
- Just like in the consolidation method, this approach requires the discipline to avoid further debt accumulation once your debts have been consolidated into your mortgage.
Choose a Debt Repayment Strategy & Stay Consistent
Although each strategy has its advantages and disadvantages, some mathematical and some emotional, choose the most appropriate debt repayment strategy for you – the one that best suits your unique circumstances and that you can stick to in the long run. As you won’t dig your way out of debt overnight, allowing some flexibility in your budget for fun and celebrating your small victories along the way will increase your likelihood of sticking to your plan over time and eventually becoming debt free.