By Priya

May 31, 2021

 
 
 
 
 
 
 
 

Show Notes

🎙 It’s super important to pay off your high interest debt before you start investing and then continue paying off your debt while you’re investing. But paying off debt isn’t easy. And the longer it takes, the more returns you sacrifice in the market. But there is hope! This episode goes through some successful strategies you can use to pay off your debt smarter and faster so that you can start investing sooner and watch your money grow. But what are those strategies, and how do they work? 🤔

This episode discusses topics like:

  • Why making only the minimum payments on your debt will keep you in debt for as long as possible;
  • Why you should start with a debt snowball and switch to a debt avalanche to become debt free; and
  • How to freeze your credit card debt at 0% interest to pay it off faster.

Transcript

Hey there, friends! And welcome back to Girl on FIRE, the financial independence podcast for independent women. 

My name is Priya, I’m a Chartered Accountant, an analyst and the creator of Paper Money Co. 

I’m also a fierce financial feminist and the host of this podcast. I believe that a woman who is in control of her money, is in control of her life.

This week we’re talking about how to pay off your debt faster & smarter. There are 4 successful strategies we’re going to cover today, so this will be a bit of a longer episode.

Paying off debt is a lot of hard work. It requires focus and sacrifice and it’s often something that can take years to achieve. But it’s absolutely achievable. 

And most importantly, it’s necessary to building lasting wealth and a comfortable retirement.

I’ve said it before, and I’ll keep saying it until it’s burned in your brain. Although Girl on FIRE is ultimately about investing and building wealth, you can’t have any of that without a solid financial foundation.

And part of that foundation is being debt free. No one wants to be paying off credit card debt and car loans when they’re retired. 

You need that money for more important things like travelling or taking a cooking class. Or just doing whatever you want.

Now, here’s something I really want you to take note of. You’ll notice that this episode and the stuff we talk about is a culmination of a bunch of previous episodes. 

You can see how it all comes together. So, we talked about needing to invest for your retirement in episodes 1 and 2. 

Whether you’re pursing early retirement or traditional retirement, you need to invest to grow your money and outpace inflation. 

We’ve talked a lot about how to start investing in episodes 14 - 18.

But investing is the more advanced stage of financial management. You need to set a solid financial foundation in place first. 

And that includes having a fully funded emergency fund, which we talked about in episode 6. 

You need to learn and practice the skill of saving, and increasing both your savings rate (which we talked about in episode 19) and your net worth (which we talked about in episode 11).

Then you start paying off your high interest debt. We answered the question of which comes first — saving, investing or paying off debt — in episode 20.

We’ve also talked about budgeting and why that’s so important in allowing you to find extra money to save or put towards debt or invest. That’s episodes 7 - 11 and also episode 21. 

But, can see how all roads are leading back to the ultimate goal of getting you ready to start investing?

Also, if you remember from episode 21, I said that you need to pay off your high interest debt first, and then start paying off the rest of your debt while you’re investing. 

And, that’s what we’re going to be talking about today — paying off your debt. 

But before we get started, I want to remind you to head to my website — papermoneyco.com/checklist and download your free copy of my Ultimate Financial Success Checklist. 

If you want to be good with money, then this is where you start. 

It’s a great checklist that shows you all the things you need to do to be financially successful.

You just need to enter in your email address and I’ll send it over to you. 

The sooner you can get your foundation set and get those good money management practices in place, the sooner you can start investing and building your wealth. 

As always, Girl on FIRE is about learning, so whip out your favourite notebook or journal and get ready to take some notes. 

If you’ve forgotten how to use a pen in this digital age we live in, you can always find the transcript on my website — papermoneyco.com/gof22.

Okay, let’s dive in to the 4 strategies for getting out of debt.

How to pay off debt using a debt snowball

Now, the first two strategies go hand in hand because they’re often compared against each other. They’re like two sides of the same coin.

They’re both ways of paying off your debt faster. I’m talking about the snowball and avalanche debt payoff strategies. 

I’m sure you’ve heard of them before. Now, something I want to make super clear here. 

To really become debt free as soon as possible, at least to pay off your high interest debt so that you can start investing, you need to be intentional about paying off your debt. 

And what I mean by that is that your minimum debt payments aren’t going to be enough.

If you really want to make a dent in your debt, you need to be making extra payments in excess of those minimum payment. 

And those extra payments need to be applied to your principal balance, not your interest.

Making just your minimum payments is probably the longest and slowest way to get out of debt. 

Here’s the thing about minimum debt payments: they’re designed to keep you in debt for as long as possible. 

Because, the longer that you’re in debt, the more interest you’ll pay on the amount you initially borrowed. 

And for your creditors, the interest that you pay is income. That’s money in the bank.

But just remember that you need to keep making those payments when implementing the strategies we cover today.

How the debt snowball strategy works

Our first strategy is using a debt snowball to pay off your debt. This is the method that old mate Dave Ramsey also recommends. 

So, what is it? A debt snowball is paying off your debts in order from lowest balance to highest balance. 

It doesn’t matter what the interest rate is, you’re only looking at the outstanding balance of your debt.

So, you start from the lowest balance debt and once you’ve paid that off, you take that extra money and apply it to the next lowest balance debt. 

And then you keep going until they’re all paid off. 

It’s called a debt snowball because it looks like a snowball. Imagine you’re at the top of a snowy mountain and you make a little snowball.

You roll that tiny little snowball off the top of the mountain. And as the snowball rolls down the mountain it picks up more and more snow, getting bigger and bigger.

So, for example let’s say you owe $3,000 on a credit card, $2,000 on medical debt and $1,500 on your car loan. 

Under the snowball method, the interest rate for those debts is irrelevant. 

Because you’re going to pay off your debts starting from the smallest balance and working your way up.

So, you’re going to continue making the minimum payments on all three debts. But you’ve got an extra $100 in your budget to put towards debt payoff. 

That extra $100 gets applied to your car loan. So, if your car loan had a minimum payment of $50, you’d be paying $150 towards your car loan every month. 

But that extra $100 goes entirely towards paying off your balance. And you keep doing that until your car loan is paid off.

Then, once your car loan is paid off, you take your extra $100 and your $50 minimum payment and apply it to the next loan. 

Now that your car loan is gone, your lowest balance is the $2,000 of medical debt. 

So, you’re still making minimum payments on your medical debt, but now you’re also paying an extra $150 on your medical debt as well.

And you keep doing that until your medical debt is paid off and then all you have left is your credit card debt.

Do you see how the amount of extra money you have to throw at your debt keeps growing as you pay them off one at a time?

That’s what creates your snowball. That’s how your snowball grows. And that’s what creates momentum.

With each debt that you eliminate, you have more and more money freed up to apply to your remaining debt.

Pros & cons of the debt snowball strategy

Now, I want to take a look at the pros and cons of the debt snowball strategy. 

When you’re using the snowball strategy, it’s going to take longer for you to become completely debt free. 

Because even though you’re paying down debt, your debt is still accumulating interest.

And, like I said before, we’re not paying attention to interest when using a debt snowball. Only the balance of you debt matters here.

Which means you’re going to end up paying more in interest. Because it’s taking you longer to become debt free. 

And because you’re not focusing on high interest debt first.

But it’s a really popular method because that very first debt gets knocked out really fast. 

And that quick win gives you motivation and momentum to keep going. So, even though it mathematically takes longer to get out of debt, it can actually increase your chances of getting out of debt.

Because those quick wins help you keep going instead of giving up because it takes so long. 

Because here’s the thing. Humans aren’t very good at choosing what’s best for them in the long term over what they need now. 

It’s easy to give up and say: “this is pointless, I’ll never be debt free” when it takes months or years to see any progress.

That’s why debt snowballs work so well, because they make psychological sense as opposed to financial sense. 

And sometimes, seeing that you’re making progress really quickly lights a fire under your booty.

It gives you motivation and the momentum you need to keep going.

How to pay off debt using a debt avalanche

How the debt avalanche strategy works

Now, the other way to pay off your debt is by using a debt avalanche strategy.

A debt avalanche is paying off your debts in order from highest interest rate to lowest interest rate. 

It doesn’t matter what the outstanding balance of your loan is. You’re paying off the loan with the highest interest rate first.

Once that’s paid off you’re taking all that money and applying it to the debt with the next highest interest rate and so on until you’re debt free. 

It’s called a debt avalanche, because it looks like an avalanche. So, if you picture a snowy mountain, what does an avalanche look like?

There’s a huge movement of snow at the top and it gets smaller and smaller as it goes down. 

So, for example, if you have $2,000 of credit card debt, with an interest rate of about 23%. 

And let’s say you also have a $10,000 car loan with 5% interest and $5,000 medical debt at 3%. 

With a debt avalanche, you’ll focus on paying off your credit card debt first. It might have a smaller outstanding balance. But it has the highest interest rate.

So you’re going to keep making the minimum payment on all three of your loans. 

But any extra money you have to put towards debt — that goes towards your credit card. 

And once your credit card is paid off, you’ve freed up some money. So, that freed-up money plus any extra that you have goes towards your car loan.

Because of all your remaining debt, your car loan is the one with the highest interest. 

And then you keep doing that until you’ve paid off all our debt and you’re debt free.

Pros & cons of the debt avalanche strategy

Now, let’s look at some of the pros & cons of the debt avalanche strategy. For one, it’ll take you longer to see progress than it would if you used a snowball. 

And that’s really the only con here. But it can be a big one. When it takes longer to see progress, it’s easier to give up. 

Because you feel like you’re working so hard and nothing’s working. It feels like you’re not making a dent in your debt because it’s taking forever to pay anything off. 

And that can make you lose motivation very quickly. You don’t have the same quick win that you get with a debt snowball. 

And that also means that you’re not building that momentum right from the beginning. 

But the avalanche strategy is the one that makes more financial sense. And that’s because you’re paying off your highest interest debt first.

Your debt is still accumulating interest, but it’s doing it at a slower rate than if you were using a debt snowball. 

And that means that it’ll be faster for you to pay off your debt, which also means you could be saving thousands of dollars in interest.

Should you use a debt snowball or a debt avalanche

So, by now you’re probably thinking: “well, that’s great Priya, but what method should I use?”.

And the answer to that is that it depends on you. You need to know yourself. 

If you know that you’re going to get disheartened when it takes too long. And that you have a tendency to give up when you don’t see results.

Then a snowball is the best option for you. At least in the beginning. 

Just because you choose a snowball or an avalanche in the beginning, doesn’t mean you can’t switch.

Because here’s the thing. Yes, a snowball will take longer and will cost you more in interest payments. 

But if it’s going to be easier for you to stick with it, then that’s the best method for you. 

So I’d recommend starting with a snowball until you feel confident that you’ve got this. And then switch to an avalanche. 

Now, the there is one other thing to keep in mind here. When you’re getting ready to start investing, you need to pay off your high interest debt first. 

And if you remember from episode 20, that’s debt with an interest rate of 7-10% or higher. So, it’ll include things like credit cards.

So, the first thing you need to do is categorise all your debt as high interest or not high interest. 

Then, whether you choose a snowball or an avalanche, focus on the list of high interest debt.

You’re going to keep paying your minimum payments on all your debt. But on that list of high interest debt, you can prioritise them in order of balance or in order of interest rate.

This way, you’re getting rid of your high interest debt so that you can start investing. 

And once you’ve done that, you can apply either a snowball or an avalanche to the rest of your debt.

Reducing your debt with a balance transfer 

Okay, so moving on, the next strategy is using a balance transfer to pay off your credit card debt. 

So, let’s say for example you have a Credit Card A with 23% interest and a balance of $5,000.

And then you do some research and find Credit Card B which has a 23% interest rate as well, but an introductory rate of 0% for balance transfers for the first year.

What does that mean? It means that you can transfer the balance from Credit Card A to Credit Card B under a 0% interest rate for 12 months. 

So, you transfer your $5,000 of debt to Credit Card B and you don’t have to pay interest on it for the first year.

This is like freezing the interest on your debt for a set period of time so that you can pay it off without interest continuing to accumulate.

The key is that you need to pay it all off — all $5,000 — before that introductory 0% interest period lapses.

So, I would call this more of an advanced debt payoff strategy, because you need to be 100% sure that you can pay off that balance before you get charged interest.

And for this example, you’d need to be paying almost $420 a month towards your debt. Making only the minimum payments isn’t going to fly here.

You need to get a bit aggressive to make sure every cent of your balance is paid of before the introductory term ends. 

Make sure you’re fully aware of the terms of a balance transfer arrangement. How long does the 0% interest period last? 

And once it ends, will you be charged interest on the remaining balance or will interest be backdated? 

What’s the exact date that the 0% interest period ends? 

Become debt free using debt consolidation

Another strategy for becoming debt free is debt consolidation. So, what does that mean?

Let's say you have 2 credit cards with outstanding balances, and a car loan. 

You’re making minimum payments on three different debts with three different interest rates. 

The goal of debt consolidation is to make one payment, with one interest rate. 

And that interest rate would need to be lower than the combined interest rate  on your debts. Otherwise, it’s pointless, right? 

So, there are two ways of doing this. First is the DIY option. And that would involve using a personal loan to consolidate your debts. 

So, back to our example. Let’s say you have $3,000 on Credit Card 1 at 23%, $2,000 on Credit Card 2 at 21% and $15,000 on your car loan at 6%.

Your total debt is $20,000, with an average interest rate of about 16%. So you’d then take out a $20,000 personal loan with a 10% interest rate. 

You use the money from the personal loan to pay off your car and your credit cards. And then you keep making payments on your personal loan, but at a lower interest rate. 

Now, this can be dangerous. You could end up with even more debt. So, again, this is an advanced strategy that you should only consider if you know that you can pay off your personal loan. 

And of course, you need to weigh up your options. Do the math to see how much you would be paying if your debts are consolidated vs unconsolidated.

I know, it’s hard work, but this was never going to be easy. But you need to put in that work to decide whether this strategy is right for you and your circumstances. 

If it’s not, then that’s totally okay. This is like a buffet. Take what you like, leave what you don’t.

But my job as a financial expert isn’t to give you the choice of it’s either my way or the highway. 

My job is to explain what your options are and how you can make an informed decision. 

Now, the other way of using a debt consolidation strategy is through a debt consolidation company. So, in Australia we have companies like MyBudget that do this for you.

I am in no way sponsored or affiliated with them or any other company, I’m just giving you an example. 

They handle the debt consolidation for you. You make one payment to them and they allocate that payment to your debts.  

But, of course, you pay them a fee. And services like that can get pricey, so it’s super important to do your homework if you’re thinking of going in that direction.

Other options for reducing your debt

Now, before I finish this episode, I just want to draw your attention to two other strategies that you could consider. 

I didn’t include them in the main strategies for this episode because they’re not as applicable to everyone. 

They  also require a lot of research and understanding and, in some cases, professional advice by someone who knows the specifics of your situation.

So, I won’t cover them in too much detail in this episode. I’ll just go over them briefly, but each one warrants an episode or even a series on it’s own.

Debt forgiveness

The first one is debt forgiveness, which means that your creditor is forgiving your debt and you don’t have to pay it off. 

It basically means that you’re freed from your obligation to repay your debt. Or they, might forgive a portion of your debt, so you at least have less to pay off. 

Under some tax laws, debt that is forgiven may be treated as taxable income which means that you may need to pay taxes on it.

Most of the time, those tax implications only arise when debt is commercial debt — meaning that it was taken out by a company or it was used to purchase an asset.

So, it’s always important to do your research.

For my listeners in the US, there may be ways to have your student loans, or even a portion of them forgiven. 

And it’s also an area that’s still evolving under the Biden administration, so keep your eye on that as well.

The reason I didn’t include debt forgiveness as a main strategy in this episode is that it may or may not happen. 

And whether a creditor forgives your debt or not, isn’t within your control. You don’t get to decide, you just have to go with it. 

I’m all about putting more money and more power in the hands of more women. And hanging your hopes on debt forgiveness is a reactive strategy. 

Girls on FIRE aren’t going to sit around waiting for things to happen. That’s why you’re listening to this podcast. 

You’re going to make things happen for yourself, as much as you can. 

Bankruptcy

Another option you can pursue is filing for bankruptcy. Which is declaring to the government that you cannot pay your debts.

By doing that, you’re legally released from most debts and you might get a fresh start.

Now bankruptcy law is pretty complicated. And it can have effects that last for years, if not decades. 

And also, there are cases where not all debt is extinguished by declaring bankruptcy. 

You can declare bankruptcy and still have debt to your name. It’s a big deal, it’s a last resort.

So, it’s absolutely not something you should enter into without fully understanding it.

Next weeks’ episode

And that’s all I have for you Girls on FIRE today!

My challenge for you this week is to head to papermoneyco.com/checklist and download your free copy of my Ultimate Financial Success Checklist. 

If you want to be good with money, then this is where you start. 

It’s a great checklist that shows you all the things you need to do to be financially successful.

You just need to enter in your email address and I’ll send it over to you. 

The sooner you can get your foundation set and get those good money management practices in place, the sooner you can start investing and building your wealth. 

As I’ve said before, paying off your debt is one of the key things that needs to happen both before and during your investing journey. 

On next weeks’ episode we’re going to be talking about the 4% rule for retirement. 

The 4% rule is often used to determine how much money you need for retirement.

We’re going to talk about what it means and whether or not it actually works.

It’s going to be a super interesting episode so you’re definitely not going to want to miss it.

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Disclaimer

The advice shared on Girl on FIRE is general in nature and does not constitute financial advice. The information shared does not consider your individual circumstances. Girl on FIRE exists purely for educational purposes and should not be relied upon to make an investment or financial decision.


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