Debt Repayment 101

One of the biggest hurdles that any of us face on our financial journey is debt repayment. Whether you are like myself and an estimated 42% of millennials who are holding student loans (Harvard IOP, 2020), or you have credit card, home, car, or medical debt, these repayments can suck up a huge percentage of your income each week and decrease your ability to make substantial contributions to savings or investing.

The first step in any debt repayment journey is taking stock of all your debts. I would recommend physically writing them down and tallying them up. Include your monthly repayment amounts, interest rates, and repayment period. While websites like Mint and Personal Capital can help you tally up total amounts, they don’t give you as complete of a picture and it can be helpful to see all your terms in one place. From there you need to decide how you want to tackle your debt. A feasible budget is an important part of debt repayment and for more information on creating a comprehensive budget check out our article Budgeting 101. Beyond deciding how much you can allocate towards debt you need to also select your repayment strategy. Below we break down some of the most popular strategies.

Snowball

Popularized by personal finance guru Dave Ramsey, the snowball method is a good method for those who find themselves lacking motivation to pay off debt or are overwhelmed by the sheer number of debts that they have. This involves paying off your debts in order of smallest to largest balance, regardless of interest rates. Frequently, after allocating a percentage of your income to debt repayment you will then apply that payment to the next smallest debt and continue paying the total allotment you have for your debt. You would, of course, continue to make minimum payments on all your debt as you go through the snowball method.

Avalanche or Debt Stacking

The debt avalanche or stacking method is when you pay your debts in the order of highest interest rate to lowest interest rate regardless of principal owed. Frequently this means that you will actually start paying off larger loans first if they have a higher interest rate than your smaller loans. Overall this method is going to save the most money in interest but can be slightly more demoralizing than the avalanche method as you will generally see the number of open loans hanging around for a longer amount of time unless your lowest debt also has the lowest interest amount. If your main goal in debt repayment is saving the most money and getting your debt paid the fastest then this is the method for you. Generally the avalanche is the method we would recommend, as it saves you the most time and money overall, if you are someone who had been on the path of debt repayment before and/or who benefits from incremental successes to maintain motivation, it may not be the one for you.

Other Important Factors

Consolidation:  Consolidation is an important factor specifically for student loans where you combine multiple loans into a single loan. This means instead of dealing with several separate loans and the payments that come with them, you bundle everything together into one loan and handle it in one monthly payment. Frequently, this doesn’t save you money as interest rates are weighted and averaged, but it can make it easier than chasing down all the different loans and having one monthly payment is easier for many people. For federal student loans when you consolidate you are also able to then adjust your repayment plan. If you have a combination of private and federal loans you can consolidate them, but it gets a little more complicated and you can have to forgo many of the benefits of federal loans.

Re-Financing: Refinancing loans applies to more than just student loans. This is where you get an entirely new loan to cover your existing ones, frequently with a different payment schedule, repayment rate, and interest rate. While this can save you money it’s important to make sure you can repay the new loan especially if you have decreased your interest rate by negotiating the higher monthly payment, the total time other promotional interest rate, or other factors. This can be especially helpful thing to do with credit cards which frequently have incredibly high interest rates. Interest rates are also incredibly low right now and this is a good time to refinance in general, whether for credit card debt, medical debt, or for your mortgage.