Is one of your New Years resolutions to pay off some debt? This is a great goal! There are some different philosophies about how to get there, let’s learn about some of them.
Debt costs us money from the interest we are charged. Let’s use an example… you have $1000 in debt with an interest rate of 20 percent a year; you are paying $200 a year for that debt. You have $100,000 in debt at 5 percent a year; you are paying $5000 a year. Then you have $10,000 in debt where you pay 30 percent for a cost of $3000 a year.
Given this scenario, there are two main schools of thought on how to eliminate your debt expenses. The first is Dave Ramsey common message to get rid of your smallest debts first. In that case, you would pay off the $1000 and save yourself the $200 a year. This helps you reduce your debt, one account at a time, and gives you a measure of success.
The other school of thought has to do with the actual cost of your debt. Get rid of the debt with the highest interest rates first, as those are technically costing you the most to have. In this case, you would start paying off the $10,000 back first, thus reducing that amount and having less at a 30 percent interest rate.
When you compare the two philosophies, look at this. Let’s say you have a $1000 extra to dedicate to your debt. You could follow Dave Ramsey and use it to pay off the $1000 at 20 percent. This would save you $200 a year. If you decided to go with the most costly debt, you could pay down the $10,000 to $9,000. This would reduce that interest payment from $3000 a year to $2700 a year — saving you $300. With the second philosophy, you save an additional $100 but you still have the same three accounts. Ramsey feels you are more likely to continue your good path of debt reduction if you have some successes.
Personally, I believe in getting the most for you money and NOT following Ramsey’s advice. Pay off the debt that is costing you the most first. Ultimately, the decision is up to you.
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