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Four Useful Ways to Pay Down Debt

By Malik Evans
Financial Wellness Manager, ESL Federal Credit Union

According to debt.org, consumer debt across the U.S. approached $14 trillion in late 2018 with more than $1.65T in auto loan debt, $1.44T in student loans, and $829 billion in credit card debt. ESL surveyed nearly 600 Facebook followers and found 81% were focused on paying down their debts.

For those who already have an established 3-6 months of emergency funds saved, here are four strategies that could help you accelerate your debt payoffs:

Put Lump Sums Toward Debts

Tax returns and holiday or annual bonuses are just some of the examples of lump sums you may receive in any given year. In 2018, the National Retail Federation found 35% of Americans planned to use their tax return to pay off debt. Applying lump sums to your outstanding debts can be a great strategy, as you can often shave months and hundreds, if not thousands, of dollars off your existing debts.

One important consideration when making lump sum payments is to be sure the payment is applied toward the loan principal and not as a pre-payment (putting money toward your next bill).

Debt Snowball

The debt snowball method looks to knock out the smallest loan balances first. As you pay off each loan, you put those extra payments toward your lowest loan balance and build momentum over time.

For example, let’s say you have three loans:

  • Loan 1 – $3,000 owed on a personal loan at 9% interest at $95/mo
  • Loan 2 – $5,000 owed on a credit card at 22% interest at $140/mo
  • Loan 3 – $12,000 owed on a student loan at 5% interest at $225/mo

Using the debt snowball method you would pay the minimum monthly payment on Loan 2 and Loan 3, and focus on paying off Loan 1.

Studies suggest that the debt snowball technique is successful by appealing to the psychological aspects of financial management. Those who use the debt snowball paid off their debts 15% more quickly because they were more concentrated with their payoff strategy. This approach is also appealing because you’re likely to get a “quick win” paying off the first debt, increasing your confidence and momentum to pay off your other loans.

It’s worth noting that while the snowball method may help you succeed in paying off the number of loans you have, the total interest paid on all your loans could be higher than other methods.

Debt Avalanche

The debt avalanche method is similar to the debt snowball, but instead focuses on paying down the loans with the highest interest rate first.

Let’s use the same three loans as an example:

  • Loan 1 – $3,000 owed on a personal loan at 9% interest at $95/mo
  • Loan 2 – $5,000 owed on a credit card at 22% interest at $140/mo
  • Loan 3 – $12,000 owed on a student loan at 5% interest at $225/mo

Using a debt avalanche you would pay the minimum monthly payment on Loan 1 and Loan 3, while focus payments on Loan 2. This method saves you more money versus the debt snowball by minimizing the principle balances on your highest interest rate loans, thus reducing the amount of interest that builds each month.

On the flip side, using a debt avalanche may require more diligence. Although on paper you’ll be saving more money, the feeling associated with having more outstanding loans may tempt you to revert to your regular payment schedule. If you choose this method, stay the course and you’ll reap more savings.

Biweekly Payments

One option you may hear about frequently is making biweekly payments to your loans (a topic most discussed around mortgages). The concept is simple: instead of making 12 monthly loan payments in a year, you’ll split the monthly payment amount in half and make two smaller payments each month. With 52 weeks in a year, you’ll send in 26 “half payments” or 13 full loan payments in one calendar year. This thirteenth payment is where the savings kick in.

Not all loan servicers offer this as a payment option, and some third parties charge you a regular fee for coordinating biweekly payments. As an alternative strategy, consider taking your average monthly payment, dividing it by 12, and adding that amount to your regular monthly bill. This way you’ll make 13 full loan payments each year, the same as you would through bi-weekly payments.

For more information, smartaboutmoney.org has a useful calculator that lets you add in your own loan amounts, sort debts lowest to highest (debt snowball) and highest to lowest (debt avalanche), or see how lump sum payments affect how much you can save.