There are plenty of techniques or strategies to reduce your overall debt – some easy and others not so much.
The ideal one for the debt company is that you pay the entire amount owed. This is probably not the best choice for you. If it was, you would’ve not been in debt in the first place. Don’t lose hope. There is one method that has been used by people in a similar situation with great results – the snowball method.
This technique, credited to Dave Ramsey, is fairly straightforward. You have to begin by arranging your debts in ascending order – from lowest amount to the highest. Now, make all the minimum monthly payments on all of these. With any funds that are left over, make an extra payment towards the smallest debt. The result – you will end up paying the smallest debt first. Now, rinse and repeat with the next smallest debt.
There are two advantages of employing this technique. Firstly, you will see your smaller debts paid off in a relatively short period of time. This is will help you stick to the program after observing these positive results. Secondly, as your smaller debts get paid down you will have more income left over at the end of the month which can in turn be used to pay down the larger debts.
Now, that you are all excited about going out there and applying this strategy, we need to offer a caveat. Employing this technique takes up more time and money to pay off the debts if you stick to this in its entirety. How does this happen you ask? Compounding. The interest on your debts is continuously increasing.
Lets explain with an example. You have a $10,000 debt, $5000 debt and a $1000 debt. For simplicity lets assume that the interest rate is the same for all three. If you were to employ this strategy you will make the minimum payments on all three followed by putting any money left over towards paying the smallest debt ($1000 in this case). The result – you end up paying the $1000 first. But, the interest on the amounts owed is largest on whats left of the $10,000 debt. Similarly, the interest on the $5000 debt also keeps compounding. So, overall you will end up making more payments for the compounding interest.
If you reverse the order of debt repayment i.e. pay the highest amounts first, you will save money overall. So why doesn’t this work? The difficulty here is summed up in one word – discipline. This second method requires a lot more discipline because you will not see results quickly. It will be slower but more effective in the long run. Whereas in Ramsey’s method, you get early momentum which keeps you motivated to stick to it.
Discipline or willpower – this is the missing ingredient in most debt repayment strategies. Most often, this is the reason why people fall in the debt trap to begin with.
If you or someone you know lacks self-discipline we urge you to try the ramsey method. You might be surprised with the results.