debt snowball

How to Pay Off These 4 Types of Debt

Denise Hill — Tue, 08 Sep 2020 17:32:44 +0000

Getting and staying out of debt is tough. Many people try and fail, or they succeed only to become ensnared the vicious cycle over and over again. Eliminating debt takes lots of grit and determination, and strategically attacking your debt will save you time, energy, and money.

Before you get started, you should know that each type of debt requires a slightly different strategy. Here's how to tackle different types of debt, and get rid of it once and for all.

Credit card debt

The best way to attack credit card debt is by using the debt snowball. With this method, you begin by attacking the smallest debt while paying the minimum on everything else. Once one debt is paid, you take all the money you were paying on the first card and apply it to the second biggest balance. Rinse and repeat.

You may be tempted to attack them based on interest rate, which is also known as the debt avalanche. And that will work. However, you must keep in mind that debt is more mental than it is logical. You probably didn't use a ton of logic to get into debt. And logic won't inspire you to get out of debt. The debt snowball approach allows you to get quick wins by conquering smaller debts before taking on the larger ones, which require more time and patience. Winning becomes a contagious habit that helps you build momentum.

You also may want to contact your credit card companies and request that they lower your interest rate. Some will and some won't, but it doesn't hurt to ask. (See also: 2-Minute Guide: How to Use Balance Transfers to Pay Off Credit Card Debt)

Car and personal loans

Auto and personal loans are a little different from credit card debt. However, they follow the same principle for repayment. First, make sure you understand the repayment terms and then contact the lender and ask them to reduce your interest rate.

In addition to using the debt snowball, a great repayment strategy for this type of debt is to call the lending agency and set up bi-weekly payments instead of paying monthly. The minimum payment doesn't change, you just make 26 payments a year versus 12. This lowers the total amount of interest you will pay over the life of the loan. When you pay more than the minimum payment, you'll slash months — even years — off the total repayment time.

Student loans

Despite how it may feel, paying off student loans is possible. You just need some discipline, patience, and a plan. For most folks, student loan debt is one of the most significant debts owed — second only to a mortgage.

The first thing you want to do is determine the total amount owed. You can do this by visiting the National Student Loan Data System or contacting your lender. From there, visit the Federal Student Loan Website to see if your loans can be consolidated, if your interest rate can be lowered, and if you qualify for any loan forgiveness programs. The Department of Education offers eight different repayment plans that may be able to assist you if you're considered low income or have special circumstances. They also provide repayment calculators and a host of other information and resources that can assist you in repaying your loans quicker.

Once you know the total amount owed, and have found a repayment plan that works for you, it's time to get busy. You want to throw ever extra dollar you have at this debt and make multiple payments a month, if possible.

Mortgage

The term "mortgage," translated from old French, literally means "death pledge." How fitting. There are several schools of thought on whether you should pay off your home early. For some people paying it off early makes sense, for others it doesn't. If you do want to knock the mortgage off your debt list, there are a few things you can do to expedite repayment.

Make bi-weekly payments

By simply splitting your monthly mortgage payment into equal parts where it's paid every two weeks, you can shave years of payments off a 30-year mortgage. If you pay more than the minimum, you expedite the process even more. You'll have to make arrangements with the lending institution to set up a bi-weekly payment plan and ensure that the extra money is applied directly to the principal.

Making one additional mortgage payment a year

This impacts the mortgage the same way making bi-weekly payments does. It's just done in one lump sum instead of over the course of a year. When you make the extra payment, you must specify that you would like it applied directly to the principal.

Make lump sum payments periodically

If you don't feel you have the ability to make bi-weekly payments or make one large additional mortgage payment, you can still pay extra on the mortgage as you are able. Paying an extra hundred dollars a few times a year will drastically speed up the repayment process. Every little bit helps.

Refinance from a 30-year fixed to a 15-year fixed

This may not make sense for everyone, but it is worth considering. By the time you're ready to begin aggressively paying off your home, you will have eliminated all other debt. You can afford to pay more. And your credit score will have gotten better and will allow you to refinance at a much lower interest rate. This strategy can cut the repayment time down by more than half.

But first, create an emergency fund

The quickest way to derail your debt repayment efforts is to have an unexpected expense. And you will have plenty. Establishing an emergency fund before you begin paying down debt is one of the keys to success. Having a few thousand dollars set aside just for emergencies will keep you on track, keep you from incurring new debt and do wonders for your psyche.

If you do have an emergency and have to use some of the money, you simply pause your debt repayment plan to replace what you spent. Use the extra funds you were applying to your debt to replenish your emergency fund. Once it's restocked, you go back to attacking the debt. (See also: Where to Find Emergency Funds When You Don't Have an Emergency Fund)

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This article is from Denise Hill of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

A Comprehensive Guide to the Debt Snowball Method

Matt Bell — Mon, 14 Nov 2011 10:24:49 +0000

Being in debt isn’t just a financial issue; it’s an emotional issue. The more debt you have, the more discouraging it can feel. Getting out from under the pile can seem undoable. But it is possible to get out of debt (I paid off $20,000 of credit card debt), and the debt snowball method can help. (See also: A Comprehensive Guide to the Envelope System)

Figure Out Which Debt to Pay Off First

Of course, paying more than the minimum amounts required by your creditors will help you get out of debt as soon as possible. However, if you have multiple debts, which debt should you pay off first?

Some personal finance writers say you should focus on your highest-interest-rate debt first (sometimes referred to as the "avalanche method"), while others say it’s best to tackle your lowest-balance debt first (the "snowball method").

It’s true that going after your highest-interest-rate debt first is usually the route to paying off all of your debts the fastest and paying the absolute least amount in interest. However, going after your lowest-balance debt first is usually the route that’ll pay off one of your debts the fastest.

Getting one debt completely wiped out feels great, and that can give you the motivation to keep going. The idea is that the lowest balance debt is like a little snowball. Paying it off gets the snowball rolling downhill, building more and more momentum as you pay off more and more of your debts.

Create Your Own Debt Snowball

Using this Accelerated Debt Payoff Calculator, enter the details of all of your debts (credit cards, vehicle loans, student loans, and others — you can even include your mortgage), starting with your lowest-balance debt. You’ll find the interest rate on your bill, usually listed as APR or annual percentage rate. For payment amount, enter the minimum monthly payment required by your creditor.

At the bottom of the list, enter a monthly amount you’re willing to add to the total minimum amounts required. The calculator assumes you’ll add this amount to your lowest-balance debt. Once that debt is paid off, it assumes you’ll roll the full amount you were paying on that debt into the payment on your next lowest-balance debt.

Fix Your Payments

There’s one crucially important point to keep in mind as you go about paying off your debts. You need to fix your payments.

Here’s what I mean — let’s say you have a $6,000 balance on a credit card that charges 18% interest and requires a minimum payment of 2% of the balance.

This month, the required payment will be $120. That’s 2% of the $6,000 balance. However, next month, assuming you didn’t charge any more on your card, your required payment will be a little less.

Isn’t that nice of the credit card company? Of course, it isn’t kindness; it’s math. Since your balance went down a little bit, your minimum required payment went down a little bit as well.

Paying this declining minimum payment will keep you in debt for approximately…forever! Sticking with our $6,000 debt example, the declining minimum payment route will take you over 42 years to get pay off that debt, and you’ll pay another $16,000 in interest.

However, if you can afford $120 this month, you can probably afford $120 next month. And if you fix your payments at $120 each month, even when they shower you with kindness and require less, you’ll be out of debt in less than nine years.

The calculator assumes you’ll fix your payments, but your creditors have no such assumptions. So make sure you’re paying the same amount on your debts each month. For the one you’re accelerating, if this month’s minimum is $100 and you’re putting an extra $50 toward it, make sure to pay $150 toward it every month — not the declining minimum plus $50.

What’s been your experience with getting out of debt? Did you focus on your highest interest rate debt first or your lowest balance debt?

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This article is from Matt Bell of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

John Cummuta: Transforming Your Debt Into His Wealth

Paul Michael — Wed, 20 Apr 2011 10:24:07 +0000

You have no doubt heard the radio ads (I hear them every day on XM Radio) by John Cummuta, making seemingly impossible claims — you can be completely debt free, including paying off your mortgage, in around five-to-seven years, using just the money you already make. Wow! And they’re backed up by “real” testimonials. Well, as I always say, if it sounds too good to be true, it probably is. (See also: Is MagicJack a Scam?)

First, let's briefly examine the radio ad that’s getting a lot of airplay right now. There are several issues I have with it. Unfortunately, I can’t find a copy of it anywhere online for you to listen to, so I have to do this from the notes I have taken after several listens.

John starts by saying “mortgages should be illegal.” Well, I think most people would agree with that one considering the state of the industry and the vast amount of interest you have to pay. But then he says that, after interest, you will pay $400,000 for a $200,000 mortgage…almost a quarter of a million dollars.

Small point, John. Maybe in your world $200,000 is close to $250,000, but $50,000 is quite the buffer zone. It’s an old advertising tactic, playing with words in this way to make the numbers sound more grandiose. It’s one fifth of a million. This is done deliberately to play off a testimonial later on, when a man says “I’ll be able to pay off my mortgage in two-and-a-half years, on a thirty year mortgage.”

See what John has done there? He sets up the average cost of a mortgage as $200,000, more than doubles it to $450,000 with interest, and then has some guy saying he’ll be paying his mortgage off in less than three years.

This is all designed to make you think you can pay off a huge mortgage in just a few years using the money you already make.

Is It Possible to Pay Off a 30-Year Mortgage in Under Three Years?

Technically, yes. But common sense should override all of this for you. Think, for a second, how on earth is this possible? To pay off the $200,000 in just three years, assuming a low 5% interest rate, would mean a monthly payment of $5,994.18! That’s over $71,000 a year! How many people in America make $71,000 after taxes? And even if you do, the next three years will be pretty tough, as you’ll have no money for, well, anything else. No food. No heat. No cars. Just a huge mortgage payment.

Clearly, unless you’re rich to begin with, you can’t pay off a 30-year, $200,000 mortgage in just three years. This is a clear case of misdirection. The guy in the testimonial doesn’t tell you how much he owes on his mortgage, how long he has to pay it off, or what he earns. It’s a meaningless statistic. I could pay off a 30-year mortgage in one week if I just had one more payment left on it.

So How Does Cummuta's Program Actually Work?

Let’s look at the program more broadly. I've talked to several financial advisors over the last few weeks, and they know all about John Cummuta's scheme. It's not a scam in the true sense of the word. It does work, or rather, it can work if you have the money. But therein lies the rub, as you'll see later on.

The plan is based on the principal idea of debt snowballing. You list all of your debts, smallest to largest, and then commit to paying them off one by one. You pay the minimum on every debt except the smallest, to which you pay as much as you afford. When that's paid off, you add the money you were formerly paying on the smallest debt to the next-smallest debt, and again pay as much as you can afford. This creates an avalanche of money that consumes the debts as each one is paid off. It also gives you great satisfaction as you check each bill off your list.

Now, what I have just told you is the essence of the John Cummuta plan, a plan that costs a lot of money. When I called to inquire, it was five payments of $79.95. It could be more or less now; they may test different price models in different areas at different times. But $400 for advice you can find easily for free on the Internet, well, that seems pricey.

Can You Be Debt Free in Five to Seven Years? Let's Try It Out!

Does it even work? Yes and no. Let's model a debt plan using John Cummuta's method. I will use the median U.S. income of approximately $52,000 (PDF) for this plan.

I will also use the $200,000 mortgage that John himself uses as an example in his ads, and assume you have been paying it off for 10 years at 5% APR. And I will add some average debt, like credit cards and car loans.

$52,000 after taxes and 401k ($500 pre-tax) is around $3,020/month. We shall round it to $3,100, just to be nice.

Now, the debt figures:

Mortgage: $162,000 at 5% ($200,000 after 10 years of payments)
Credit Cards: $14,000 at 13% — $420 minimum payment (3%)
Car Loan 1: $18,045 at 6% (This assumes the average $24,800 purchase price, a $415 minimum payment, and 50 months left of the average 72-month loan.)

And as the average family has two cars...

Car Loan 2: $12,540 at 6% (This assumes a lower purchase price of $20,000, a $391 minimum payment, and 36 months left of 60.)

These are all based on averages I found. Some people have much more debt, including student loans, home equity loans, and so on. But we'll keep this simple.

OK, Let's Do a Debt Snowball!

Here's one I created using a debt snowball calculator online.

Adding no extra payments and using the figures above, it came to 115 months to pay everything off. That's nine-and-a-half years to be debt free. Not bad, and that's just using the money you earn right now. The combined debt is $2,299.00 per month, leaving your family a tight $801 per month for food, heating, clothing, and all those other household expenses. Something tells me you won't be adding much to your savings plan over the next 10 years.

But Cummuta estimates five-to-seven years.

Well, let's aim for the high end. Seven years.

To get everything paid off in 84 months, you'd have to add an additional $650/month to the debt snowball. That leaves an impossible $151/month to live off.

Want it paid off in five years? Hey, Cummuta can make it happen.

Just add an additional $1,620/month to the original debt snowball, instead of that measly $650.

YES! You'll be debt free in five years! But there is the tiny hurdle of figuring out how to survive on -$849/month. Reading Wise Bread may help, but surviving on negative $849 seems tough for even the most frugal shopper.

For Most Of Us, Being Debt-Free in Five Years Is Insanely Tough (If It's Even Possible)

These are all just examples done with average U.S. figures. You may have more debt and more income. You may have less debt and less income. But the Cummuta plan seems to be one of extreme sacrfice to the point of having no life at all. If you want to become debt free in five-to-seven years, you'll have no social life, food will be scarce, you won't be able to afford to drive anywhere, no one gets gifts, clothing is out, and you may just lose your sanity, too.

Yes, debt snowballing is a good idea. I think it's a good way to pay off debt, if you do it right and set reasonable goals. But you don't need to pay John Cummuta hundreds (or tens of thousands) of dollars to figure it out. And please, don't set yourself a goal like five years unless you have some major income left over each month that you're stashing in a Swiss bank account.

Be careful everyone. Do your research on John Cummuta and other debt programs before you hand over your precious money to anyone. These debt elimination plans seem to be good for one person and one person only — the one selling them to you.

This article is from Paul Michael of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: