Editorial Policy

3 methods for paying off debt

Miranda Marquit

May 11, 2015

Debt can be overwhelming, especially when you have multiple debts and you're not sure where to start. A system to prioritize your debts takes some of the guesswork out of your repayment plan.

There are three main ways to pay down your debt: the snowball method, the avalanche method, and the level payment method. All have their advantages, and one will likely work for you.

Before you jump into paying off any debt, you need to establish ground rules for yourself:

  1. “Stop adding to your debt,” says Mitch Korolewicz, an accredited financial counselor with OK Money Coach. As long as you spend more than you earn, no debt payment plan will be effective. That means build a budget, cut expenses and stop using credit cards as a crutch.
  2. Next, continue making at least the minimum payment on all your debts. Effective debt repayment plans operate under the assumption that you will meet your minimum obligations on all of your debts.
  3. After you have established a baseline of paying the minimum on all your debts, figure out how much you have each month for debt reduction. This extra payment can come from money you save by cutting back in other areas of your budget or by increasing your income with side jobs or by selling unneeded items.
  4. Separate debt with tax-deductible interest from debt with nondeductible interest, suggests Don Reichert, president of Capital Design Associates, a wealth management firm. He points out that student loan debt, mortgage debt (including some home equity loans) and business debt all usually have lower interest rates and can result in tax savings. Make your minimum payments on tax-deductible debt, but don't rush to pay the loans off early if you have other debt.

Now that your tax-deductible debt has been separated out, it's time to look at your non-deductible debt (credit card debt, payday loans, personal loans and auto loans) and work to pay it down. Here are three ways to achieve your goal:

Debt avalanche method

“You pay the least amount of interest with the debt avalanche method,” says Korolewicz. First, list the debts you carry and the corresponding APR attached to that debt. Tackle the loan with the highest interest rate first, putting any extra money toward that bill while paying the minimum payments on all your other debts.

When you pay off your first loan, take the entire monthly amount you were putting toward the highest-interest debt and use it to reduce the next highest-APR loan on your list. For example, if your first loan had a minimum payment of $50 and your extra debt reduction payment was $100, your total payment was $150. If the second loan on your list has a minimum payment of $45, you will add the entire $150 you were paying before, making the total going toward the next loan on your list $195.

As you progress, your debt payments accelerate and are more effective as the interest rates expenses involved become progressively lower.

Korolewicz says this method is ideal for consumers who are more interested in saving money and don't need a quick psychological boost.

For consumers who need a motivational boost, there's the debt snowball method.

Debt snowball method

With this method, you order your nondeductible debts according to how much you owe rather than by APR. Start with the smallest balance. You tackle that debt first and pay it off quickly, providing you with a feeling of accomplishment that helps you build momentum. Over time, as your monthly payment amount “snowballs,” it makes it easier to deal with the larger debts since your payment is bigger. While you may pay more in interest overall, you are more likely to stick with the plan, since you see results faster.

Level payment method

When you are struggling with the avalanche or snowball method, Korolewicz suggests that you add between $5 and $20 to each debt's current minimum and maintain that level payment until each debt is paid off. “Do not reduce your payments as your minimum payment amounts drop,” he says. The level payment process works slower than the avalanche or snowball, but you always know what you will pay each month. This method is ideal if your situation doesn't allow you to be more aggressive with your debt reduction.

Once your nondeductible debt is paid off, you can repeat the process with your tax-deductible debt if you are determined to be completely debt-free.

Whichever method you choose, it may be worth your while to work with a nonprofit credit counselor. The counselor can advise you on how to budget and prioritize, and in some cases, establish a debt consolidation plan. Reputable nonprofit programs charge nominal fees and often can negotiate with lenders for reduced interest charges. Just make sure you find a nonprofit credit counseling service that is affiliated with the National Foundation for Credit Counseling or the Financial Counseling Association of America.

On the flip side, don't be tempted to use a debt settlement company, which will offer to negotiate your repayment for a fee, reducing the total amount you pay to your creditors.  Debt settlement companies sometimes advise you to stop making payments, which can further damage your credit.

There are no shortcuts to paying back your debt. Commit to yourself that going forward, you will pay on time each month, and once any card debt is paid down, that you will pay any balance due in full each month.

A plan can help you feel more confident about your situation, and give your debt reduction a direction more likely to lead to long-term success.