How You Can Pay Off Your Debts Real Fast

Debt is one of the biggest vices of our generation. An average American has $20.000 of debt. If you are serious about your financial position, paying off the high-interest loans is the first step on the journey to financial independence. These high-interest loans can cost you much more than anything that you will ever be made on an investment.  In this article, I shall be discussing how you can pay off your debts. This is theoretically the best standalone technique that reduces the finance cost as much as possible while keeping the time to pay off the debt to a minimum as well.

Before we proceed to explore how the method works, let me clarify the two requirements for the successful implementation of this model. First and foremost, the biggest assumption of this technique is that you are able to make the minimum payments on all your debts, as required by your finance provider(s), and still have some left-over money every month. The model then focuses on utilizing these funds in the most efficient way. If you do not fulfill this requirement, you should consider other debt repayment strategies such as refinancing or debt consolidation.

The other requirement for this strategy, like any other financial strategy, is your willingness and commitment to the idea of paying off your debts. No strategy, no matter how effective, will help you if you are not fully committed. It takes time and effort to improve your financial position. This strategy will help significantly reduce the time taken to pay off your debts, but only if you stay focused.

The magic technique

The method is very simple to implement. It is called the Debt Avalanche. The main focus of this strategy is on reducing your finance cost, i.e. the interest paid on top of the principal amount. This has the dual benefit of saving you the money as well as reducing the time it takes you to clear the total debts that you owe.

The technique starts by making a list of all the different debts you owe and then ranks them by their interest rates from highest to lowest. The method works as follows:

  1. Make a list of all the debts that you owe.
  2. Rearrange the list by their interest rates raking the debt with the highest interest rate on top.
  3. Estimate the amount that you can spare towards paying off your debt every month.
  4. Start paying off the minimum amount on all your debts.
  5. Use all the money left over in your budget to pay off the highest interest rate debt as soon as possible.
  6. Once the first debt on your list is cleared, use that amount to pay off the second debt.
  7. Continue until all your debts are cleared.

As you can see, it is a very simple technique. It focuses your finances towards paying off the loan that carries the highest interest rate, doing the most damage to your financial position. It then utilizes all the available finances as well as the savings you make in terms of financial costs (interest) to build momentum like an avalanche that buries your debts away in no time, hence its name “The Debt Avalanche”.

The technique in itself is very simple but provides the best mathematical option for paying off your debts as quickly as possible while paying the smallest possible amount. The simplicity of the method means that it can also be paired with other techniques to give us even a better result than either of the techniques may provide if used alone.

Let’s see how it works

Let’s illustrate the concept with a small example. Imagine that you currently owe five loans: a student loan, a car loan, a payday loan and two credit card loans totaling $42,000. The first thing would be to list all the relevant information down:

Loan Type

Amount

Minimum Payment

Interest Rate

Student loan $22,000 $230 6%
Car loan $13,000 $210 5%
Payday loan $3,500 $365 44%
Credit card 1 $2,500 $135 27%
Credit card 2 $1,000 $70 32%

Now that we have compiled all the information in one place, the next step is to rearrange the list and sort it by the highest interest rate. The new rearranged list should look like this:

Loan Type

Amount

Minimum Payment

Interest Rate

Student loan $22,000 $230 6%
Car loan $13,000 $210 5%
Payday loan $3,500 $365 44%
Credit card 1 $2,500 $135 27%
Credit card 2 $1,000 $70 32%

Once we have arranged everything, it is time to decide how much you can spare each month towards paying off your loans. The minimum amounts on the loans sum up to a total of $1,010, and our monthly contribution should at least be more than that. Let’s assume this amount as $1,250. Now, every month you need to pay off the minimum amount on all the loans that you owe and use the remaining $240 to pay up the top one remaining on the list. Your payment plan should look like this:

Month
Payday Loan
Credit Card 2
Credit Card 1
Student Loan
Car loan
Total Payments
1-6 $605.00 $70.00 $135.00 $230.00 $210.00 $1,250.00
7 $364.66 $310.34 $135.00 $230.00 $210.00 $1,250.00
8 $430.95 $379.05 $230.00 $210.00 $1,250.00
9 $810.00 $230.00 $210.00 $1,250.00
10 $799.46 $240.54 $210.00 $1,250.00
11-31 $1,040.00 $210.00 $1,250.00
32 $87.28 $1,162.72 $1,250.00
33-37 $1,250.00 $1,250.00
38 $563.72 $563.72

In the above example, we can see that by using the debt avalanche method, you can be debt-free in 38 months, or just over 3 years. However, if you stick to the minimum payment as required by your loan providers, it would take about 11 years for you to pay off the loans. Yes, there would be a difference in monthly as well as the total payments, so let’s have a better look at that.

With the minimum payment option, you would have ended up paying about $54,100 in total that includes the principal of $42,000, as well as $14,100 as a finance cost in the form of interest. By using the simple technique above, we have reduced that cost down to only about $4,800, which is almost one-third of the total original interest paid. Thus, we can see that this technique not only reduces the total payment time down to less than a third but also saves us a lot of money in the form of interest.

But why bother?

As we can see in the example above, the debt avalanche method significantly reduces the interest cost; in this case, by about a factor of three. However, when we look at the total payments over the years, a cost reduction from $54,100 to $46,800 does not look that impressive. So, the real question is, Why bother?

First things first, we need to clarify one thing. Comparing the figures of 54,100 and 46,800 is not a fair comparison. It contains the principal amount of $42,000 which is the original borrowed amount. This means that this figure neither belongs to us nor are we paying it. We are only returning the principal amount. The real comparison should be between the costs we pay, i.e. the interest amounts in the two scenarios.

With that out of the way, let’s start with the benefits of using this technique. The first benefit, as mentioned more than once, is the cost-saving. This not only provides you with the savings in interest but promises that no other arrangement or prioritization can provide more savings than this, making it the default choice.

The second benefit is provided by its simplicity. As the technique is fairly simple, it is easy to implement and does not even need an expert to do all the math. Moreover, the method can also be combined with other options that you may have, such as debt consolidation, refinancing or debt transfer, in order to achieve better results than any of these techniques provide individually.

The last, and in my opinion the biggest, the benefit of this technique is that this gives you a better perspective and an opportunity to develop a habit of going above and beyond to actively control your financial opposition. When you are making only the minimum payments on the loans and other debts that you owe, you reduce your monthly contribution as soon as one of your debts clear off. However, following the debt avalanche makes clearing the debt your first priority and does not reduce the monthly contribution. This means that you keep on contributing as much as you can every month towards improving your financial position, making it your habit to save every month.

Once you get into the habit of saving, the benefits are limitless. First of all, you can build your emergency fund. However, for me, the most important aspect of saving is when you get that amount invested every month and it starts compounding on itself. If you take the same $1,250 every month and continue saving that amount till the end of year 11 (the same time we would have been debt-free with the minimum payment option), the size of your portfolio at the end of that period will be over $170,000 at an annual return of only 10%. Now that is something looking forward to. With these methods, you can easily pay off your debts.

 

Tell Us What You Think
0Like0Love0Haha0Wow0Sad0Angry

0 Comment

Leave a comment