Paying Down Debt

A primary goal of my weekly newsletter is to help money topics feel more approachable and digestible for my readers. That’s why I encourage, in my articles and on social media, my readers to share any questions or concerns they have about money. My promise in return is that I’ll address those specific topics in future posts.

This week’s topic comes from my hometown friend Brittany who’s interested in strategies for paying down debt (Thank you, Brittany!). She’s wondering the best way to pay down her debts and when debt consolidation might be a good choice.

Who among us hasn’t looked at our student loan balance or credit card statement and understood precisely how Joe Exotic felt in this scene from Tiger King? It’s likely student loans and credit cards aren’t the only debts weighing on your mind. You may also have a mortgage, car payment, personal loans, and/or medical debt.

Let’s begin with the myth that there’s no such thing as good debt. Some of you, like me, may be recovering from your days of taking Dave Ramsey’s word for everything related to your finances. Dave has a lot of helpful advice (see his take on life insurance, for example), but “there’s no such thing as good debt” is just bologna.

This video by NerdWallet makes some great points related to debt:

• Not all debt is created equal.
• Debt can be a necessity or provide opportunity.
• Good debt is affordable and helps you move forward.
• Bad debt is expensive and drags you down.

The reality is, certain debt can help increase your net worth in time or add value to your life in an important way (like your mortgage). And while having no debt is still preferred by most, this type of debt is not bad within reasonable limits. What qualifies as “reasonable limits” will depend on your specific financial situation. Other debt (like store credit cards) is debt that should, and usually can, be avoided.
Now that we’ve addressed the elephant in the room, what’s the best way to work on paying down your debts?

First, write a list of all your debts and label each one as either good debt or bad debt. Remember, good debt is affordable (low interest rate) and helps improve your net worth over time. Bad debt is expensive (high interest rate) and does not contribute to your financial wellbeing. Focus your debt payoff energy (extra debt payments) on your bad debts first, and once all bad debts are paid off, you can move on to paying off your good debts.

Next, decide whether you want to pay down your debt using the snowball method or the avalanche method.

The Snowball Method

• List your debts by balance, from the smallest to the largest.
• Don’t pay attention to the interest rate on each debt.
• Pay the minimum payments on each debt every month.
• Put any extra debt payments toward your smallest debt until it’s paid off.
• After your smallest debt is paid off, add the amount you were paying toward it each month to the next debt on your list.
• Keep repeating this process until you’re debt free.

The primary benefit of the snowball method is psychological. It feels good to see your list of debts shrink quickly, which may motivate you to keep paying off more debt and avoid taking on new debt. The flip side is you will likely pay more in interest over time.

The Avalanche Method

• List your debts by interest rate, from highest to lowest.
• Don’t pay attention to the balance of each debt.
• Pay the minimum payments on each debt every month.
• Put any extra debt payments toward your highest interest debt until it’s paid off.

After your highest interest debt is paid off, add the amount you were paying toward it each month to the next debt on your list.
Keep repeating this process until you’re debt free.

The greatest benefit of the avalanche method is mathematical. By paying off your highest interest debt first, you pay less interest over time. The downside is you’re not guaranteed the same “quick wins” you get from the debt snowball.

When to Consider Debt Consolidation

Putting a plan in place for paying off your debts, like the methods we discussed above, is often all you need to make your way to debt freedom. But there are times when consolidating your debts can give you another boost.

Debt consolidation may be worth looking into if you have a good credit score (670+), prefer fixed payments, want to simplify your finances with fewer monthly payments, and can afford the debt consolidation loan payment. When these apply and you can get a lower interest rate, it’s a win/win.

Some potential negatives of debt consolidation loans are the associated fees (like loan origination fees and closing costs), a higher minimum payment, and the possibility of a higher interest rate.

It’s important to keep in mind that consolidation won’t address what caused you to go into debt in the first place. While it can feel like a relief to simplify your finances, be vigilant against introducing new debts to your life following debt consolidation.

Okay, we’ve covered a lot. And now you may be thinking, “Wait a minute! She didn’t answer the question. What’s the best way to work on paying down my debts?” Here’s a quote to ponder:

“We’re so focused on figuring out the best approach that we never get around to taking action.” — James Clear, Atomic Habits

You know you much better than I do. The best approach to paying down your debt is the one that you can stick with and that will be the most motivating for you. The important thing is to take action toward your commitment to a healthy relationship with debt. Your net worth will be all the better for it.