Debt isn’t a dirty word—far from it. In fact, borrowing money and carrying some debt can help you establish a credit history and reach longer-term financial goals like buying a car or owning a home. The important part of debt management is planning: Are you tracking it and do you have a plan for paying it off?
Keeping tabs on debt is arguably the simpler of the two tasks. Creating a basic spreadsheet with your current debt obligations and their terms, annual percentage rates and balances is an excellent start. It’s helpful to separate your debt into long-term (five years and more) and shorter-term or revolving (think credit cards). And websites and apps like Credit Karma or Mint can help you track debt successfully so payments are made on time.
Paying down debt is a trickier undertaking that requires a strategic approach. These are a few of the smartest ways to get the better of debt:
- The Snowball Strategy. This approach calls for zeroing in on the smallest balance on your debt inventory and focusing your excess cash there. When that item is wiped off the books, move on to the next-smallest and work your way up. The snowball strategy allows you to start small and build on your success over time. But, remember, going small means it will take you longer to attain freedom from debt.
- The Avalanche Method. Proponents of the avalanche strategy identify their highest interest-rate debt and start chipping away at it. From there, they work their way down the line. The avalanche method can wipe away your total debt faster than the snowball method, but there are fewer “small wins” along the way. This plan requires resolve and consistency, but it pays major dividendsA cash payment to investors who own stock in the company. in the form of less interest paid to your creditors.
- A Straight Refi. Refinancing—essentially repackaging existing loans with better terms—is a common way to clean up your balance sheet on everything from credit cards to much larger debts. With interest rates at historic lows, mortgages and student loans are two of the best candidates for a refi. This option offers flexibility on how much you pay and how often. For instance, you might try for a lower monthly payment to free up money for your emergency fund, or keep your payment the same but reduce the term (and the overall interest paid) by a couple of years. Refinancing is a handy option—if you have a good enough credit history to qualify for better terms.
- Roll It Up. Consolidating multiple smaller debts into one large loan is a common approach for paying down credit cards and can also work for other types of debt—an excellent option if you have assets to use as leverage. For instance, if you have $200,000 of equityThe amount of money that would be returned to shareholders if a company’s assets were sold off and all its debt repaid. in your home and $50,000 of credit card and outstanding grad school debt, you might consider taking out a home equity line of credit (HELOC) allowing you to roll those smaller debts into one payment with a lower interest rate. Personal loans, which are not secured by an asset, are another way to roll up debt—although personal loans tend to come with higher interest rates than other approaches.
- Pay Minimums and Invest the Rest. A final way to approach debt management is to pay the monthly minimums (assuming interest rates remain low) for a defined period and put excess cash toward saving and investing. This method requires cash flow, planning and possibly expert advice. The key is to make sure your investments are growing faster than your debt. For instance, if you refinance student loans at a 2.5% interest rate and pay them regularly, you can then direct more of your salary toward maxing out tax-deferred 401(k) contributions. If you have cash left over each month, put it into a diversified brokerage account. Over time, the growth of those investments should exceed 2.5%—a much more efficient use of resources than being prematurely debt-free. You’ll need to pay your debt down at some point, but in the meantime you can benefit from the compounding interest from your investments.
Which method should you choose? The one that keeps you on track to meet your financial goals. Remember, there’s no need to go it alone. As The Planner You Can Talk To, we’re here to work with you on the debt-paydown blueprint that makes sense for you and your family. Give us a call! We’re always happy to help.
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