What Is the Smartest Way to Pay Off Debt?

By Jessica Dosseh

Whether you are using your momentum to push up or push down when paying off debt, it's not hard to recognize the difficulties that come with it. Nevertheless, digging yourself out of that seemingly perpetual pit is as much about changing your thinking as it is about reprioritizing your money.

Why is paying off debt important?

I'm assuming I don't need to convince you why paying off your debt is necessary, but, just in case, here's why.

Just because you are in a bad or terrifying situation doesn't mean you need to stay there. It's not easy to make change happen, but at some point, you either need to believe in your ability to change your reality or stay stagnant.

Debt can often feel like a gaping hole that never seems to end. It's the stress. It's the thing blocking you from reaching your financial goals. Maybe you've spent a little here and a little there; sometimes out of necessity, and pretty soon, you've ended up borrowing way more than you ever intended to.

Despite it being an overwhelming process with a little trial and error, you may be able to find a strategy that helps you reduce your debt over time.

So what can you do?

Know how much you owe.

This may seem blatantly obvious, but you would be surprised how many people blindly pay bills with no strategic plan because of the fear of facing their debt.

The reality is that merely paying off the minimum payments keeps you stuck in the never-ending cycle of debt.

This may not be what you want to hear, but I hope you take some time to understand your budgeting process inside and out, or at least build a functional system. If you haven't done so already, feel free to read our article on How to build a budgeting system. 

The first part of this system is understanding where your money is going, because you can't solve a problem you don't understand. A lot of the time, the people you owe money to are counting on the fact that you don't understand how their system works.

Your feelings about the amount you owe are valid, but hiding from the realities of your situation will keep you trapped.

So here's the first task:

• Call your "loan" provider and ask them for the amount of debt you owe, the APR, and the monthly minimum payment on the card. Do this for all categories of debt that you owe.

• Now, order your debt in a table from largest interest rate to smallest interest rate.

Here is an example:

Once you know how much you owe, it's time to use your budgeting system to help you reprioritize your money and get out of debt.

Understanding debt payment strategies.

Before we dive into using our budgeting system to help us make conscious decisions, let's first look at some debt payment strategies.

Debt Consolidation 

Debt consolidation is when you use a loan to pay off your debt by rolling your multiple debts into a single payment, ideally at a lower interest rate. This could potentially make your payments more manageable.

Suppose you're dealing with a manageable amount of debt (perhaps less than 30% of your monthly gross income) and want to reorganize your debt with an interest rate lower than your highest interest rate. In that case, debt consolidation might be a good place to start. However, if you naturally have an excessive spending habit or an overwhelming amount of debt, it might be better to focus your energy on a different strategy.

For more information, consider reading: What Is Debt Consolidation, and Should I Consolidate?

Push UP or Push DOWN.

The Avalanche Method

The avalanche method is about paying off the highest interest rate first while continuing to pay minimums on the others, then the next highest rate, and so on. Pushing down makes the most mathematical sense, but you do need to sacrifice your instant gratification because you won't see quick changes. Nevertheless, when you start to gain momentum, this route may help speed things up and help save on interest over time.

It's like watching a plant grow. The seed sits under the dirt for a long time; when you're not looking, it starts to sprout, grow, then becomes a full-grown tree with fruit.

Even though this method may feel hard, learning to build a compounding momentum will help you in the long run throughout your financial journey. "It's not a sprint, it's a marathon," and if need be, it's okay to walk a 5K.

Here is an example using the table from above:

With the avalanche method, the "Credit Card" payment becomes your top priority because it carries the highest interest rate. So, the goal is to do your best to rearrange your budget distribution and try to find 1-10% from your gross income and allocate it towards the payment of the highest interest rate. Once the credit card debt is paid, you move on to the personal loan. This won't be easy, but as you develop good habits, you'll gain a lot more in the long run.

The Snowball Method

If you need short-term wins to motivate you, then the snowball method might be for you. The snowball method focuses on paying off your smallest debt ($) amount first while continuing to pay minimums on the others, then paying off the next smallest amount, and so on. Pushing the ball up can be a feel-good process because you're taking bite-sized pieces. The most important thing to remember here is to not give up as it gets more difficult.

Here's an example:

With the snowball method, arrange the debts by balance, from smallest to largest, disregarding the interest rate. Every month, put extra money (or a percentage of your income, 1-10%) towards getting rid of your smallest debt. Once you pay it off, take the monthly minimum plus your extra percentage and put it towards the next-smallest debt. So in our case, you would pay the auto loan first, then move down the list.

Choosing between the avalanche and snowball method depends on your discipline and ability to motivate yourself—either way, you need to use the approach that empowers you to get it done.

The Pivot Method

The pivot method is just a hybrid between the avalanche and snowball method.  

Sometimes when it gets too hard to push up, it's okay to pause, pivot, and push down or vice versa. We all have a point where we lose momentum, so instead of getting despaired, we can just change directions.

If you start with the snowball method and you reach a point where you start to doubt your ability to reach the end, it might be time to pivot. It's hard anyways, so why not continue with the hardest? In the end, the compounding effect might give you just as much gratification as paying off the smallest debt. At this point, because you are dealing with the largest interest rate, you might want to consider negotiating your rate down: How to lower your credit card interest rate (script included)

Rearrange your budget

Now that you know more about each debt payoff method, it's time to go back to the second section of "How to build a budgeting system" and do some optimization so that you can pull a small percentage towards your debt payments. Once you've found your base amount, return to your debt payment plan and implement the method of your choice.

Let's talk about a hypothetical

Let's budget $30,000 a year to pay off our debt.

Kathy is a school teacher who makes $30,000 a year — $2,500 a month. Currently, 20% of Kathy's income goes to paying off debt minimums, and the rest (80%) is for living and general costs. The first thing Kathy could do is rearrange the 80% of her income and determine if she can pull some of it towards her debt payments. Let's be optimistic and say she can put 5% ($100) a month towards her debt payoff. At this point, she needs to decide whether or not she wants to pay her highest interest first or her lowest debt amount first. Paying the highest percentage will take much longer than paying the smallest amount; nevertheless, the method she chooses depends on her preferences and discipline. At this point, there is not much left to do. It's time to wait and be patient while gradually increasing the amount she puts towards her debt payoff.

Before you go.

Getting out of debt isn't just about getting rid of debt. It's also about adjusting your lifestyle and mindset around debt so that you don't continuously end up in the same situation because of your habits. The more debt you pay off does not mean the more expenses you can put right back on your credit card.

A debt repayment strategy like the avalanche and snowball method are only part of the work. You also need a practical budget and a sustainable spending plan.

Good Luck.