Should You Pay Off Installment Loans Or Revolving Credit First
Debt is usually broken down into two groups: installment loans and revolving credit. Here’s how each works:
- Installment loans: Installment credit comes in the form of loans that have equal monthly paymentsoften called installmentsover a set repayment period. For example, when you get a 30-year mortgage loan, you get a lump sum to cover the cost of the sale, then the loan is paid off over that time. So you know exactly what you’re going to pay every month and when the loan will be paid in full.
- Revolving credit: The alternative to a lump-sum loan amount, revolving credit accounts give you a line of credit that you can draw on, pay off and use again. Credit cards and lines of credit are considered revolving credit. Lines of credit typically have a draw period, followed by a repayment period, similar to an installment loan. With credit cards, however, there’s no set repayment period and your monthly payment is based on a percentage of your balance.
The decision of which type of debt to pay off first depends on a few things, so it’s important to understand the full extent of your situation.
Write A Budget And Stick To It
Track your spending for a month to see where every penny goes. Set up a spreadsheet on paper or electronically and enter expense categories such as mortgage, utilities, food, gas, car, medical, debt, entertainment, childcare, misc. etc. everywhere you spend money. Once you have an idea how much you spend, decide where you can cut back. This step is the hardest because you need to cut your lifestyle in every category if you are really serious about getting out of debt. This is the Live on Less Than You Make scenario. Any extra you squeeze out of the budget should go to debt.
Then you have to make a plan for how you will pay your debts off.
Knock Out The Smaller Balances First
Paying off your credit card debts according to the interest rate is a smart move, mathematically speaking, but can take longer to reach your first repayment milestone. The longer youre paying on your debts, the more likely you are to get frustrated with the process. If you need to be motivated to stay on the path to debt freedom, paying down the smallest balances may be your best bet.
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When youre dealing with multiple debts, trying to pay off all of them can be overwhelming. Being able to knock out a few smaller bills right away can build your confidence and give you the push you need to stick with your debt repayment plan. Once you get all the little debts out of the way, you can decide whether you want to keep paying your debts based on the balance or switch to paying the highest interest one first. The important thing is to get on a debt payoff plan that works for you and that will help you get out of debt fast.
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Paying Off Credit Card Debt
If you can’t afford to pay off your credit card debt all at once but you still want to pay off your balance, what do you do? We’ve established that just making the minimum payment on all your cards isn’t the ideal way to tackle debt. If you’re ready to step up your debt repayment efforts, you can pay off the cards with the highest interest rate first or start with the cards that have the lowest balance. The process of paying down debt is known as amortization. There are different ways of going about it.
One popular strategy called the Snowball Method works like this: You keep up with the minimum payments on all your cards and make extra payments on the card with the lowest balance. By focusing on paying off the card with the lowest balance first, you’ll have the satisfaction of checking debts off your list more quickly. This can be a powerful motivator. Once you’ve paid off your first credit card, you can apply the money you were spending on credit card 1 to making payments on credit card 2 and so on. You’ll have momentum to continue your debt repayment.
Debt Avalanche Vs Debt Snowball: An Overview
Paying off debt is no easy task, especially if you just pay the minimum amount due each month. To get free and clear, you often have to accelerate payments. There are two distinct strategies to settle outstanding balances in this way: the debt avalanche method and the debt snowball method.
Both debt avalanche and debt snowball apply to most kinds of consumer debt: personal, student, and auto loans credit card balances medical bills. Each method requires that you list out your debts and make minimum payments on all but one of them. That one you pay extra money towards, with the aim of wiping it out first. Once it’s erased, you target another balance the extra money you apply towards it could be the minimum sum you had to pay on the erased debt.
The two strategies diverge over which debt you single out first. In the debt avalanche method, you pay extra money toward the debt with the highest interest rate. With the debt snowball method, you pay down the smallest debt first and work your way up, regardless of the interest rate.
While both are useful strategies to get debt out of your life, one method might be easier for you to stick with and make a bigger impact on your finances. Let’s look at each approach in-depth, covering the pros and cons of the debt snowball and the debt avalanche. Then, we’ll discuss some special considerations when tackling debt. By the end, you should have a good sense of determining which debt repayment method is best for you.
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Debt By Balances And Terms
While the debt avalanche method might save you more money, you may be better off using the “debt snowball” method. Rather than focusing on interest rates, you pay off your smallest debt first while making minimum payments on your other debt. Once you pay off the smallest debt, use that cash to make larger payments on the next smallest debt. Continue until all your debt is paid off.
The debt snowball method is a good strategy if you respond well to little victories and dont have the patience to tackle big balances first.
If you have a small debt, like a few hundred dollars, you might be able to pay this off in a few weeks or a couple of months. This first win may be the motivation you need to stay the course and pay off your remaining debt.
What Is The Best Way To Pay Off Your Debts
There are two trains of thought & popular strategies.
- Debt Avalanche Method: Pay off the credit card or loan with the highest interest rate.
- Debt Snowball Method: Pay off the smallest balance regardless of interest rate.
- Which Method is Better? From a purely mathematical standpoint the debt avalanche method is better since it would save you the most interest expense. However, as noted above, we are emotional creatures. We often make decisions based on emotions then justify our actions after the fact by collecting data that supports our choices. Thus if you are trying to create new money habits it can be beneficial to use the debt snowball method as it allows you to make easy wins early and helps you better view and appreciate your progress and have a sense of accomplishment after each small debt is paid off.
So, do you work first on a $5,000 debt at 10% interest or the $800 debt at 6% interest? The first option makes better financial sense because you will save more in interest. But the second option makes emotional sense if you want to gain momentum and need to feel like you are getting somewhere and achieving. Either way, you are moving forward and getting closer to you goal.
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Which Credit Cards Should You Pay Off First
If you’ve decided to focus on your credit card debt first, and have multiple accounts, prioritize the card with the highest interest rate to save more money on interest.
To maximize your savings, use the debt avalanche method: Make just the minimum monthly payment on all of your cards except the one with the highest interest rate. With that account, put all of the extra money you can afford to pay it down faster.
Once you’ve paid off the balance on the card with the highest interest, take all of the money you were putting toward it every month, and apply it to the card with the next-highest rate in addition to the minimum payment you’re already making. Again, you’ll continue to pay just the minimum on your other cards.
You’ll repeat this process with each card until all of your credit card debt is paid off. The strategy is called the debt avalanche method because your payments will increase with each successive card, accelerating your progress more and more.
Another way to approach your credit card debt is with the debt snowball method. This approach works mostly the same as the debt avalanche method with one key difference: Instead of focusing on your balance with the highest interest rate first, you’ll pay down your smallest balances first.
Pay Off Small Loans First
Some borrowers like watching their loans disappear, which encourages them to continue focusing on debt payoff. If that sounds like you, use the debt snowball method. Youll pay off the smallest student loan first, rather than the one with the highest interest rate.
You can also opt for a combination method. Rank your loans by interest rate, and if several have the same or similar rates, pay off the smallest one first. Youll still get some savings from choosing the debt avalanche strategy, but youll enjoy early, quick wins, too.
As you pay off each loan, roll over your payment to the next highest interest rate or the next smallest balance.
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Be Aware Of The Pain/pleasure Dichotomy & Consciously Rewire Your Brain
See buying as pain and denying oneself as pleasure because it will ultimately lead to the pleasure of debt freedom. If you are single you only need to convince yourself of your new plan. If you have a spouse or significant other they will need to join you on this journey or they will sabotage your efforts. Have a heart to heart talk about your debt. Explain how it makes you feel and how you envision your lives without this weight on your shoulders. Debt is an emotional thing so use that emotion to help drive you to your goal.
Personal financial gurus can help provide inspiration and boost willpower. In addition to popular mainstream commentators like Suze Orman& Dave Ramsey, there are a number of influential alternative voices online like Mr Money Mustache, Ramit Sethi& hundreds of others.
First Choose Which Debt To Pay Off First
If you have multiple credit cards, loans or other debts, its important to look at a few factors when deciding which to pay off first. To save the most money in the long run, pay down the debt with the highest interest rate, or pay the debt that is closest to your credit max. Both of these options will help raise your credit score in addition to relieving some of your debt. If youre interested in learning more, check out our advice on Keeping Score.
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Which Method Should I Pick
The best method is the one you can stick to, so pick the best method for your own situation and personality. If you are someone that needs more motivation to pay off debt, take advantage of the quick wins with the Snowball Method. If you are fully committed and want to save as much money as possible, stick with the Avalanche Method.
Use the calculator above to try out both methods and see how the calculations differ. You can switch between the two methods to see how much interest you’ll pay with each method, and when you’ll be debt free!
As you can see, paying down debt can be complicated, so getting a clear picture of your finances and cash flow is a crucial first step to setting yourself up for success. Monarch is helping thousands of households navigate their financial life and achieve peace of mind, join them bysigning up today.
How Much Extra Should You Pay To Payoff Your Mortgage Early
You dream of paying off your mortgage early.
You long for the day when you are debt free.
But how do you do it?
How much must you pay each month to be out of debt by a certain date?
What if you wanted to pay off your mortgage in 15 years instead of 30? How much would you save?
The good news is this mortgage payoff calculator makes figuring out your required extra payment easy.
You choose how quickly you’d like to pay off your mortgage, and the calculator will tell you the required extra monthly payment to get it done. It will also tell you how much interest you’ll save!
However, before you start making your extra payments, there are a few factors you’ll want to consider first . . . .
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Consider Refinancing Options To Save More Money
As you’re paying down your debt, consider whether there’s a way to refinance some of your debt at a lower interest rate. This may be possible if your credit has improved since you first took out the debt. And if you have good credit, you may be able to qualify for a balance transfer credit card with an introductory 0% APR promotion.
Check your credit score and look into opportunities to consolidate or refinance your high interest accounts with a lower interest option. This process alone won’t solve your debt problem, but it can make it easier to manage, save you money and help you become debt-free sooner.
Using Our Calculator To Start Your Plan
To see how much interest you are wasting on loans and credit cards use the calculator above. Simply enter your loan amount and interest rate and choose the date you would like to see the debt eliminated. Then click the compute button. The calculator will populate the three lower spaces to show your monthly payment, number of months needed to pay off the debt, and the interest you are spending to have this debt. No need to enter dollar signs, commas or percent symbols. It’s a smart calculator.
After you decide on your debt payment plan, remember to reward yourself a little with each credit card or loan you eliminate. Dinner at a restaurant will taste so much better knowing you are well on your way to being debt free.
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Prepay Vs Invest Calculation
Here is an example of Prepay versus Invest calculation using my own situation as an example. I will be using two calculators that you can use to calculate your own numbers.
The variables are:
The saving is not bad. If I factor in the loss in tax deduction, then my NET saving is probably about $21,000.
Now, using the Investment Calculator at Calculator.net, if I instead invest the $116 per month for 24 years at 9% average annualized gain, I would end up with $111,232.after 20% federal capital gains tax plus state tax, this is about $89,000!
For my specific situation, investing would be about 4.25 times more beneficial!
Should You Payoff Your Mortgage Early
That depends and theres no cookie-cutter answer. It comes down to whether you prioritize eliminating debt or growing your investment portfolio.
If you receive a windfall and youre tempted to pay off your mortgage, you might be better off investing the money and sticking to your normal repayment plan.
However, if you prefer the peace of mind of eliminating debt, this freedom could win over potential gains from investments.
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What Does Debt Snowball Mean
The debt snowball is a type of accelerated debt repayment plan. You list all of your debts from smallest to largest. You then devote extra money each month to paying off the smallest debt first you make only minimum monthly payments on the others. When the first balance is settled, you move on to the next smallest.
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Calculate By Loan Term
This option will help you to determine how long it will take to pay off your loan, based on the loan amount, the interest rate, and the proposed term of the loan. If youre simply playing around with different numbers, you can adjust the length of the loan term to determine a payment level thats acceptable to you.
But this option will also give you another important piece of information you need to know, and thats the amount of interest youll pay over the length of the loan. The longer the term, the higher the total interest paid will be. In that way, youll be able to make an intelligent decision about both the monthly payment and the total interest cost of the loan.
When you select this option, youll be asked two additional questions:
- Loan term ranging from 12 to 84 months.
- Extra monthly payment enter any additional principal you plan to add to your monthly payment, but leave it blank if you only intend to make occasional additional payments.
For demonstration purposes, enter 60 months for the loan term. Then hit the black Calculate button.
The loan payoff calculator will display two results:
- Your estimated monthly payment will be $198.01.
- Interest paid $1,880.60, which is the total amount of interest youll pay over the 60-month term of the loan.