We’re Soaring, Flying – 3 methods for Breaking Free of your Bad Debt

High School Musical has a lot to teach us. Ski resorts are a fantastic place to meet hot men. If someone is trying to implement change, and you don’t like it, performing on the table of your work canteen will put them back in their place instantly. And when we spend beyond our means, the world can see us in a way that’s different than who we are (I will try but I can’t promise there won’t be more stunning lyrical references – sorry, not sorry).  

Credit cards and high interest loans can leave us entangled in a web of debt, and breaking free of your bad debt burden can be a monumental task.  

But at Fearless Girl Finance, we know that clearing burdensome debt is the best thing you can do for your financial freedom. That’s why we’ve compiled three failsafe strategies to help you chip away that debt – because financial security is not a want, but a need.  

The Snowball Method 

The Snowball Method focuses on your total debt size. Begin by listing your debt, from smallest to largest. In this method, you don’t worry about the interest rate, just the amount you owe. As you continue to make your monthly minimum payments on each debt, throw your weight into overpaying the smallest one as much as you can.  

For example, imagine you had the following debts: 

1. Car Loan: $5,000 balance, 6% interest rate, $200 monthly payment 
2. Credit Card 1: $1,500 balance, 12% interest rate, $50 monthly minimum payment 
3. Credit Card 2: $3,000 balance, 15% interest rate, $100 monthly minimum payment 
4. Payday Loan: $500 balance, 20% interest rate, $75 monthly payment  

With these debts, your monthly minimum payment is $425. While you keep making your monthly minimum payments, you focus on putting any additional money that you can into clearing the debts in this order: 

1. Payday Loan 
2. Credit Card 1 
3. Credit Card 2 
4. Car Loan 

Once you have cleared the Payday Loan, you use the money you would have used as the minimum payment (in this case $75) to work on clearing Credit Card 1. As each debt is cleared, you will be able to add more and more money into clearing the next one. This should help your debts to reduce faster, and the visible progress will keep you motivated.  

The Debt Avalanche Method 

This method follows the opposite strategy by ordering the debts by interest rate. While you continue to make your monthly minimum payments, any additional income will go to the debt with the highest interest rate. In this case we would order the debt like this: 

1. Payday Loan 
2. Credit Card 2 
3. Credit Card 1  
4. Car Loan 

By paying your debt in this way, overpayments will go off the total sum of the debt. The remaining sum will accrue less interest for you to pay off, saving you money in the long run. However, this method can lack the motivational kick of the snowball method as you may be paying multiple debts over a much longer period of time. 

The Debt Consolidation Method 

With Debt Consolidation, you will apply for one final loan of the exact amount of money you need to re-pay on your other debts. If you are approved for this, you will receive the loan and use it to pay off your existing debts immediately. The benefit of this is that a bank loan will usually have a lower interest rate than a credit card or payday loan. This could end up saving you thousands in the long run. Let’s see how this would work in practice.  

   1. Car Loan: 

Balance: $5,000 with an interest rate of 6% 

Total Interest = $5,000 x 0.06 = $300 

 

2. Credit Card 1: 

Balance: $1,500 with an interest rate of 18% 

Total Interest = $1,500 x 0.18 = $270 

 

3. Credit Card 2: 

Balance: $3,000 of interest rate of 15% 

Total Interest = $3,000 x 0.15 = $450 

 

4. Payday Loan: 

 Balance: $500 with an interest rate of 20% 

Total Interest = $500 x 0.20 = $100 

So the total interest paid across these debts is $1,120. If you took out a loan of $10,000 to repay those debts, and your loan had a fixed rate of interest at 8%, you would pay $800 over the course of your repayments, which is a huge saving in your pocket.  You can use this calculator to work out how much your monthly repayments and interest would be if you took out a loan to consolidate you debts. 

However, while this sounds fantastic, there can be some pitfalls. First, if you have a bad credit score due to missed repayments, you may not be approved for a loan with a low interest rate. And if you are an impulsive spender, it may be tempting to spend part of the loan on pleasurable things like holidays or handbags. Debt consolidation makes it harder to learn good habits around clearing debt.  

For more good habits, click here to find out how to structure a budget you can finally stick to.

Breaking Free of your bad debt 

Debt can feel overwhelming, especially if you have multiple sources of debt. But making a plan and taking action to face your debts will put you back in control of your finances. And with these strategies, there’s not a star in heaven that you can’t reach.  

 

Will you try one of these methods to clear your bad debt? Let us know in the comments or tag us on Instagram @fearlessgirlfinance_