In this post, I’ll teach you the best way to get out of debt, the reasons why, and how to get started.
First you have to face the numbers. Adding up what you owe is probably the scariest part of the entire process. My advice: rip off the band-aid, add up how much you owe, and make a budget so you how much of your paycheck is going to payments.
By doing this, you’ve empowered yourself with knowledge and you’ll be mad enough at the debt to take action.
But that sense of empowerment can quickly dissipate when you realize that you have no plan for attacking it. Throwing a few hundred bucks extra at the credit card and some of your bonus paycheck at the student loan is NOT a game plan.
Haphazardly throwing extra money at random debts is depressing and will make you feel poor. It also doesn’t stop you from accumulating MORE debt down the road.
Instead, you need a SYSTEM to get out of debt. A concrete, step-by-step plan. The only problem is there are so many different opinions out there on what the best plan is.
Do you pay off the highest interest rate first, or the smallest balance first, pay off extra on all of them at once, or consolidate the loans?
So. Many. Opinions.
That’s when I turn to research.
The research is clear: the snowball method is the best way to get out of debt.
Harvard Business Review published an article about a study conducted by Boston University. They tested three blind sets of data, in which they discovered that focusing on one debt at a time, and starting with the smallest debt, participants got the best results.
Another study by the Kellogg School of Management concluded with similar insights. It found that “the number of accounts closed better predicted successfully completing the program than the dollar amount an individual had paid off.”
Essentially, psychology plays a bigger role in determining the best way to get out of debt than math does.
I love the story retirement expert Chris Hogan tells about the economist that he was coaching. Chris was trying to explain the snowball method to help him get out of debt.
The economist stopped him and argued that the snowball method wasn’t the most mathematically efficient; instead, he should pay off his debts by interest rate.
Chris replied to the economist (paraphrase): if this were about math, you wouldn’t have any debt.
The economist looked at Chris and replied, “Proceed.”
Emotional momentum changes the speed at which you get out of debt. It changes what you view as a need versus a want. It changes your drive to work extra, to delay the vacation, to stay focused on what you want MOST.
If the issue of paying off debt were purely mathematical, then we’d want to use the avalanche method and pay off loans by highest interest rate. But since we are humans and not computers, we have to take our own human nature into consideration.
Plus, by the time you calculate the difference in interest between the snowball method and the avalanche method, it usually isn’t a significant amount, especially because most people who use the debt snowball end up finishing it sooner than they first estimate.
When you set up your debt snowball, you line up your debts from smallest to biggest according to their balance. You pay only the minimum on all the but the debt at the top of the list and put everything to can into killing that first one. When that debt is paid, everything you paid on the first one gets applied to the next debt on the list.
Using a debt snowball without even paying extra can reduce the time you are in debt from 10 years to three, simply because you are working systematically.
And at the same time, the snowball method offers a simple plan to follow. You can easily track your progress and as you gain emotional momentum, so you will your numbers.
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