You have seen millions of articles online about “why you need to pay off debt” or “27,000 painful tips to save money so you can pay down debt.” In fact I wrote more than a few of those. That is not the purpose of this article. Today, I want to talk about how to pay off debt in a planned fashion to optimize returns, success, and general day to day headaches.
Let’s take a scenario that isn’t too unreal for many of us. It may be better or worse than your current situation, but you’ll be able to follow along. You need to start by listing all of your debts. Not just the ones you’re current on, but every single debt you own (family, medical, long stopped calling you because it’s been years, rent, food, gas, all of them.) Also, next to each item list the amount owed, monthly required payment, interest rate, and current or not current.
Here is our imaginary list:
Before we start any of the how to pay off debt conversations there is a corollary to any of the strategies. If you can’t keep you current bills current without borrowing more money you don’t need to worry about paying down debt, you have a income situation. In this mode you must organize your bills by life priority. Generally this is food, shelter, power, car/gas (to get to work with), basic communication and so on. You can organize for your lifestyle, but don’t miss this step. If you’re short on money professional debt collectors will pressure you to make bad financial decisions. Just pay down the list until you run out of money and that is all you can do. Don’t stress beyond that other than earning more income. Your life will get very stressful if you skip necessities to pay those who yell the loudest. Now on to the debt paying strategies.
How to Pay Off Debt Classically
Classic financial advice would tell you to pay down your debts highest fee/interest rates first. This means keeping everything current unless there is no fees associated with it (this would include stiffing family/friends who don’t have a contract with you) and then pay extra on the highest interest rate. Mathematically this is absolutely correct. I won’t bore you with an analysis of the debts above, but it would tell you to pay off credit card 3 first, then credit card 2 and so on. If you stick to this plan you will pay off everything the fastest for the least amount of money. The problem with this plan is the “if”. It’s the hardest to stick to because you’ll be waking up sleeping giants of defunct credit who will get on you again now that they know you are alive, there’s not quick wins that people tend to require to stick with something, and there is no morality decisions in the planning, just cold hard numbers.
How to Pay Off Debt using the Dave Ramsey Debt Snowball
This method, made famous in The Total Money Makeover, is to simply list your debts from smallest total owed, to most total owed, ignore the defunct one for now, and then pay off the balances as you can while keeping everything else current. In this method you would pay Medical Bill 1, then Credit Card 1 and so on. The good part about this method is you get quick wins (Yay I have one less bill!), but it will take you longer, and it takes good logic out of your choices sometimes.
How to Pay off Debt Using my Logic
The first thing I do is check my morals. Professional lending companies understand there are risks lending to people so if I can’t pay I don’t feel bad about not paying them (for now.) However, family, friends, child support, alimony, medical bills are not lending companies so I do all I can to make those commitments first. Then I hit the financial institutions with remaining cash I have in my budget.
Long ago I got over what people think so I’m not afraid to shake up old creditors to negotiate with them. If you get very stressed from negotiating with people skip this step and move to the last step of my plan. In this step I call up my old debts and offer to deal with them. If they are willing to wipe out much of the fees on fees they add when things go defunct (often 2 to 3 times the natural debt) then I’ll pay them off for the “deal”. If they won’t deal or I don’t have enough money for them to make a deal I politely tell them I will call them back next time I have money and ignore them until then. I also let them know exactly how much I have to deal with and if they don’t deal I will call my next creditor. They know someone will take that money and they want to be it. It’s amazing how well it works, just make sure to get the deal in writing. They will lie to you.
After the negotiation phase I look through my debts to see what will improve cash flow. For me I feel a win when bills aren’t sucking away as much of my income. So I look at the bills I have and see if I can pay any of them off to get rid of the payment (perhaps the low medical bill or smaller credit card.) If I can’t the next choice is to pay on something that has a payment that changes with balance. That means I would pay a partial on a credit card (maybe dropping the payment $10 or $15 per month) instead of paying on the car or defunct debt that doesn’t affect my monthly bills due. After doing this for a few months you’ll feel the pressure coming off your shoulders as you required bills shrink. It is a rewarding feeling.
Overall personal finance is personal. Any of the above methods will eventually get you out of debt, but no method works that you can’t stick with. Knowing who you are and working with it is the best step in learning how to pay off debt.
