Will this be the year you experience debt freedom?Â
If you have debt, you probably made a New Yearâ€™s Resolution this year to work hard to get your debt under control. Think how wonderful it will be. Â No more calls from creditors. Debt comes in many shapes and sizes so whether your debt is from credit cards, student loans, or anything else, these 4 strategies will help you tackle your debt and get it controlled once and for all.
The Debt Avalanche
The best way to get out of debt, according to math, is a strategy known as the â€œdebt avalanche.â€ With a debt avalanche, you prioritize your debt by an interest rate. Each month, pay the minimum payment of every debt, but the one with the highest interest rate gets more. Put every extra dollar you have into that debt until it is paid off, then move on to the debt with the next highest interest rate.
To better understand the math, forget about how big each loan balance is and look at the interest rates only. That is how much you pay for each dollar you borrow in that account. If you have one account with a $1,000 balance at 20% and another with a $10,000 balance at 10%, you should pay off the $1,000 balance first even though the $10,000 loan costs more each month. You pay 20 cents for every dollar you borrow annually on the first account and only 10 cents per dollar on the larger loan. If you have $1,000 to put into a debt payment, paying $1,000 in the bigger loan will save you $100 per year. Paying off $1,000 in the smaller loan will save you $200 per year.
Even though the payment does not change in either loan in the scenario above, as neither loan is paid off completely, you are financially better off paying extra on the loan with a higher interest rate. That is the fastest path to debt freedom.
The Debt Snowball
Finance guru Dave Ramsey offers a second strategy called the â€œdebt snowball.â€ Unlike the debt avalanche, which focuses on using the best mathematical option to pay off your debt, the debt snowball uses psychology to motivate you to pay off your debt.
The setup and payment method is the exact same as a debt snowball and a debt avalanche. However, instead of prioritizing by interest rate, Ramsey argues that you are best off prioritizing your debt payoff by loan balance. Ramsey believes that focusing on smaller balances first will help you achieve a mental win as your debts are paid off and give you momentum to keep paying off the larger ones.
While this is financially not a sound strategy compared to the debt avalanche, Ramsey does make a good point. If you know you will feel better paying off loans rather than saving money on interest overall, this plan works. Like the debt avalanche, it has helped countless people get out of debt for good.
Earn More Money
When most â€œexpertsâ€ talk about getting out of debt, they focus on budgeting and cutting expenses to open up more of your cash for debt payments. While these are good and important strategies, they neglect to mention the most powerful option you have to improve your finances: earn more money!
Whether it is by doing a great job at work and getting a promotion, picking up a part-time gig on weekends, or starting your own side hustle, you have the power to earn more.
Think about it like this. If you were to exercise two hours every day but still go home and enjoy a pint of Ben & Jerryâ€™s every day, you will not lose weight. Why? Because even though you worked so hard on your outputs, in this case, calories burned, you did not do anything to control your inputs. Personal finance works the same way.
You can budget and strive for frugality, but if you earn $20,000 per year you probably wonâ€™t become wealthy by simply cutting costs. While managing your expenses is important, there is eventually a point where you are wasting time to save a few dollars here and there. If you used that time for income-producing efforts instead, you could possibly end up in a better financial position.
What if you could cut your budget by $1,000 every month and increase your income by $1,000 every month? What if you could build on that over time and earn an extra $2,000 per month? Now getting out of debt doesnâ€™t look like such a challenge! In personal finance and personal fitness, your inputs are often more important than your outputs.
If you think youâ€™re too busy to earn more through your own side hustle, take a good look at how you spend your time each day. How many hours do you spend watching TV or enjoying â€œNetflix and chillâ€ time? If you can carve out a couple of hours per week, you have enough time to get started.
Make a Forever Resolution
Personal finance and personal fitness share more in common, people often use them for New Yearâ€™s resolutions. However, New Yearâ€™s resolutions are infamous for quick failures after a month or two. Instead of New Yearâ€™s resolutions for your finances, make a forever resolution.
Resolve today that this is the year you will get your finances organized. This is the year you will make real progress in getting out of debt. This is the year to take charge of your money and stop letting your money control you. It all starts with you and make the decision that this is the year you become debt free.
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