There are lots of theories about how to best eliminate your debt, but the best one I’ve seen is the Debt Snowball Theory (The Simple Dollar has a good explanation of it). In short, you list all of your debts, ranking them by interest rate. You pay the minimum payment on all of them each month, but you also put an additional amount into the one with the highest interest rate. You keep doing that, until that first debt is paid off. Then, you take the amount you were paying on that first debt (minimum payment plus the additional amount you could scrape up) and that’s your new additional amount, which you pay into the second debt, on top of its minimum payment. You continue doing this, snowballing the amount into each debt, until they’re all paid off.
If you do the math, it’s the fastest and cheapest way to pay off all of your debts. And once I have income, I’ll be implementing it into my own financial plan. But, as it is with every person, I have a special situation. While my credit card debt easily falls into the plan, my other two debts do not.
The first debt, my student loan payments, doesn’t quite fit into the equation because I’m not making any payments yet. Depending on when I go back to school, I might not be making payments on them for years to come. I want to figure them into my equation, but that might not be the best idea. I could put a certain amount of money each month into my high-yield savings account, designating that money as future student loan payments. However, I would lose money that way, since the interest rate on my credit card is far higher than the interest I would gain in the savings account.
My other debt, my car loan, doesn’t fit neatly either, because it has no interest rate. It’s just a flat monthly payment. For that loan, it would be much better to continue to pay monthly, and put any extra into my savings account, rather than try and pay it down quickly.
I suppose the Snowball Plan just isn’t for me. It’s likely that by the time I start making payments on my student loans, my credit card will be paid off. I guess this is actually a good thing, although I’m a little bit disappointed that I don’t get to make use of my new knowledge.
The debt snowball is definitely for you. Even if your car payment is no interest–how is that possible?–you’ll be able to double up on payments and make more than the monthly payment thus paying off the loan more quickly.
Visit my site and search Dave Ramsey. Read his total money makeover.
Thanks, too, for participating in my Friday Financial Forum.
I look forward to you participating next week, too.
The car loan has no interest because it’s from my grandmother. She sold me her car, and I pay her monthly.
I don’t see how paying off the loan more quickly would be helpful – the extra money I would pay into it each month could be put my savings account, and earn interest. The only reason to pay it off quicker would be to make my grandmother happier, although she looks at this as a way to “spend her money,” which he financial advisor keeps telling her to do.
Thank you for the advice though, I’ll look up Dave Ramsey on your site tommorow!
Hi Stephanie,
Congratulations, on starting to think about money and personal finances early. I just wanted to share something from my school days with you, hoping to change your mindset about debt.
When I started my grad school, we (me and the better half) each had taken out huge education loan. But since we did not have to start paying it until we finished studying we didnt not “count” it. Next we went a bought a car. We probably could have done without it. We used some of the left overs from education loan and ALL our savings till that day, to pay for it in cash (no car payments) but it comepletely broke our bank. We didnt plan for future expenditure, and slowly started putting books and anything-beyond-the-everyday expenditure on credit cards. As we got comfortable doing this, our “lifestyle” started getting better and we just kept piling it on credit cards. When the finance charges started to catch up, we started to feel the burn. The better half got a job before me, but it was terrible to watch most of the paychek vanish, to pay back loans π Its a disgusting feeling, when you finally start earning, but you cant keep the money because there are too many loans. And the interest on the loan is money you just give away, something you have never really got to use or enjoy.
Anyway, what I am trying to say is, dont treat your student loan and car loan like they dont matter. It is still debt. It is still something you need to pay back. Its still money that needs to go OUT from you at some point. High interest or not, pay it off fast. Just think of it, when you finally finish school and start working, with no or very less loan, you will easily be able to say, “richer than you, seriously!” (you probasbly shouldnt say it out loud, though) π
(Whoa, long comment, sorry kinda got carried away. Don’t want to see someone else make the same mistakes as me.)
ispf: Don’t worry about the long comment, it just means you care about what you’re writting!
Thank you for the advice. I do hope to pay down my credit card as soon as possible, and then start creating a cushion for when I have to start paying my student loan. However, I don’t see any advantage to paying extra into my car loan, since paying it faster won’t save me any money (since there’s no interest). Instead, I want to put any extra I could pay into the bank, where it can pile up for my “student loan cushion.”
I do however want to…
Make all my payments each month
Pay off my credit card as fast as possible
Start putting aside money for my futute student loan payments
I hope my plan settles your worries! =) If not, suggestions are always welcome.
Sound like a good plan. Good Luck!
Seems like an another good way to get rid of the debts. Good post man, it’s worth it
Good advide, The Debt Snowball Plan is for everyone who has debts. Other options may be to negotiate your debt, or make an individual Voluntary Arrangement with your creditor. We have to make an effort to avoid the debts.
The debt-snowball method is simple, but many people dont think of it until they have someone explain it to them. The method contains only a few easy to follow steps. First, the person must list all his debts in order from smallest to largest. If two debts have a similar balance, then he should payoff the debt with the largest interest rate first. It may make more sense to pay off all the debt with the largest interest rates first, but an important factor of the debt-snowball method is the role that psychology plays. The borrower takes on a more positive attitude when he sees fewer bills every month. If the borrower has the willpower, it may be better to pay off the balances with the highest interest rates first, but this theory is not part of the debt-snowball method.
Thank’s, very interesting article. Congratulations! It’s a very good plan.
While I am by no means a financial expert, I think you’re looking at your student loan and car payment wrong.
What I’d recommend is continue paying the same to the car (0% is still 0%), but only save enough to give yourself a small cushion… then put all extra money into paying off the credit card. Your goal should be to have the car and credit card completely paid off before your student loan starts. If you pay off both before the student loan payements start, then save everything you can to put towards the loan later.
@David – this entry is kind of old (if you look at the date at the top, you’ll see I wrote the original post in January of 2007!), but thank you for your thoughts. It may not come across in the entry, but what you described is EXACTLY what I was talking about in the entry, and exactly what I did, although it took a while. Now both the car and the credit card are paid off, and I’m paying off student loan interest as soon as I can.
The biggest thing ever to help our family was reading Total Money Makeover by Dave Ramsey. Not only did we cut our credit card bills in half each month, but we only took out half the amount of trash as we normal did, one can instead of two! Amazing how far a little effort goes. π
This credit card debt relief option will not work for everyone and fortunately, there are other alternatives for getting out of debt. It is just a matter of deciding what is going to work best for you.