Three Ways to Get Out of Debt

Charles Schwab2023-11-04

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💫 Short Summary

The video segment explores various strategies for managing debt, including the avalanche method, snowball method, and consolidation. It emphasizes the importance of stopping debt accumulation, knowing the exact owed amount, paying as much as possible, and staying committed. Personal circumstances play a significant role in the effectiveness of each strategy, highlighting the need for individualized financial planning and discipline to become debt-free.

✨ Highlights

📊 Transcript

✦

Strategies for managing debt:

00:32

The avalanche method prioritizes paying off high-interest debt first to save money in interest payments.

The snowball method focuses on paying off the smallest balance first to provide a sense of accomplishment and motivation.

Consolidation involves combining all debt into one payment, potentially with a lower interest rate.

Various options for debt consolidation, such as taking out a new loan or balance transfer, should be carefully considered before deciding on the best approach for debt repayment.

✦

Overview of Debt Payoff Strategies.

04:23

The avalanche method involves paying off debts with the highest interest rates first, saving money in the long run.

The snowball method focuses on paying off debts with the smallest balances first, providing a sense of accomplishment and motivation.

Debt consolidation involves combining multiple debts into a single payment, simplifying the process and potentially lowering interest rates.

The effectiveness of each strategy is influenced by personal circumstances, highlighting the importance of tailored financial planning and discipline.

00:00If you feel overwhelmed by debt, you're not alone.

00:03In 2019, the average American owed more than $6,200 in credit card debt.

00:08One of the biggest challenges of getting out of debt is knowing where to begin.

00:12Having a specific method can help.

00:14Here are three strategies to manage debt, especially debt with an interest rate higher

00:18than 5%:

00:20the avalanche method, where you pay off the debt with the highest interest first,

00:25the snowball method, where you pay off the smallest balance first,

00:29and consolidation, where you combine your debt.

00:32We'll walk through each method to help you determine which one may be right for you.

00:37While it may require some sacrifices, it is possible to dig yourself out of debt.

00:42Let's say you have debt on four different credit cards.

00:46To start, write down all of your outstanding balances and the interest rates on each.

00:50Based on these totals, if you only paid the minimum on each card, you might not be debt

00:55free for almost 12 years.

00:59With the avalanche method, you'll prioritize paying off the debt with the highest interest

01:03first.

01:05The idea is by focusing on the most expensive debt first, you'll save money over time.

01:11For the other cards, pay the minimum every month, then put everything else you can toward

01:16paying off the highest interest rate card.

01:20After the highest interest rate debt is paid off, you'll apply those payments to debt with

01:24the next highest rate, and so on.

01:27The avalanche method will save you more money in interest payments than if you were to pay

01:31off lower interest debt first, so mathematically, the avalanche method is a better way to pay

01:37off debt.

01:38If you're able to put an extra $500 per month toward this debt, the avalanche method could

01:44save you more than $20,000 in interest compared to just paying the minimum.

01:49It'd also shorten the life of your debt to only three years.

01:53But for some, avalanches have to start somewhere—maybe as a snowball.

01:58With the snowball method, you'll pay the minimum of all your balances and then put anything

02:02left toward the debt with the smallest balance first.

02:05So, in this example, you'd pay off the $1,300 debt first.

02:09It may seem financially unwise to pay off anything but the highest interest debt first,

02:13but with the snowball method, you're able to pay off a higher portion of one of your

02:17balances with each payment.

02:20Take that $1,300 debt: A $500 payment would pay off 38% of that account, while $500 toward

02:28the debt with the highest interest rate would only be 5% of that account balance.

02:33A study in the Journal of Consumer Research found that when subjects paid down a higher

02:37portion of a balance on their debt, they were more motivated to keep going.

02:42Though it's not the most cost-effective method, in the long run, it was more effective.

02:47Don't underestimate the power of psychology.

02:49The sense of accomplishment from completely paying off one balance can motivate you to

02:54stay disciplined with the others.

02:55A third strategy for managing your debt repayment is consolidation.

03:00This is combining all your debt into one, so you can make a single monthly payment,

03:05ideally, one with a lower interest rate than your existing accounts.

03:09One way to consolidate debt is to take out a new loan or line of credit to pay off your

03:14existing debt.

03:16Another choice is a balance transfer, which means moving your balances onto a new credit

03:20card.

03:22This may be a good idea if you're able to open a new credit card that offers 0% interest

03:26on balance transfers.

03:27But typically, this 0% interest is only for a limited time, like a year or 18 months.

03:33So, don't transfer your balances unless you're sure you can pay them off during this introductory

03:38period or if the new interest rate will be lower than your current combined interest

03:43rate.

03:44In our example, if you combined everything into a 0% balance transfer for 12 months,

03:48you'd face payments of $2,500 per month.

03:52That's pretty steep, so make sure you're able to handle that amount, or you'll face interest

03:56at the end of the intro period.

03:59Once it's paid off, keep it that way.

04:01Pay your total balance monthly and manage your debt; don't let your debt manage you.

04:08To review, avalanche saves money by paying debt with the highest interest rate first,

04:12snowball may maximize motivation by paying the smallest balance first, and consolidation

04:18may be useful if you can afford to combine all your debt into one payment.

04:23There isn't one right way to dig yourself out of debt.

04:26Your numbers may be different than the ones we used in our example, which means the difference

04:30in total payoff could vary from one strategy to the next.

04:33The most important thing is to stop adding to the debt, determine exactly how much you

04:38owe, pay as much toward it as you can, and stick to it.

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