A Consumer Debt Repayment Strategy

Okay, maybe you're not drowning in consumer debt, but the water level is just too high and seems to be getting deeper. The interest charges are steep, and you know that if you start falling behind in your payments, the late fees will just add insult to injury and make your balances even higher. You'd like to get out of the situation you're in before you get soaked. What's the best way to go about it?

First, plug the hole

Are you still using credit? If so, attempting to get out of debt while you're still incurring more of it is like trying to bail out a boat that's still leaking.

Review your expenses and compare them to your income. If you're spending more than you're earning, you're probably using credit, even if only for the occasional "emergency." In order to bail out of debt, you'll first have to plug the leaks in your budget.

As you make your budget more seaworthy, look for ways to reduce your expenses to the point where you create a cash surplus. You can then use this surplus to accelerate your debt repayment. This is a key element to any strategy that accelerates repayment of consumer debt.

Line up your ducks

List all your unsecured debts (don't include your mortgage, student loan, and/or car loan); rank them from the one with the highest interest rate charged to the lowest. Hopefully, you're current with all of them (including the unlisted ones); if not, first direct any surplus to getting current.

Once all your debts are current, make the minimum payment on all of them and direct any surplus toward increasing the payment against the debt with the highest interest rate. As the minimum payments required on all your debts start to go down (as happens with credit cards), don't pay less on your total debt. Instead, make the minimum payments on each debt and keep shifting the "extra" to increasing the payment on the debt with the highest interest rate.

Take your best shot

Once the debt with the highest interest rate is paid off, add the amount of the payment you were making toward it to what you're paying on the debt with the next highest interest rate. Once again, as the minimum payment requirements on other debts with lower interest rates decline further, put the "extra" created toward this highest-interest debt.

Because the amount you pay toward each debt increases in size as you move down the list of your debts, this repayment strategy is often referred to as snowballing.

An alternative approach

Some snowballing methods recommend that you pay off your debts starting with the smallest balance first, regardless of its interest rate, and also apply to this debt any surplus, while keeping your payments the same each month on all of the rest of your debts (regardless of their decreasing minimum requirements). While this approach offers the psychological satisfaction of paying off smaller debts quickly and paying extra against the principal on all your debts, it may not save you as much in total interest charges as the approach outlined above.