We focused more on debt and credit cards in our last article, however we did not just want to sound negative on credit cards and there is more to getting out of debt than just stopping using credit cards. How should you go about paying off your debt? What debts might you leave for a while? How do you not go back into debt? These are some of the questions we hope to answer in our part 2 of baby step 2, getting out of debt.
Snowball vs Highest Interest- This is probably the hottest, most controversial take on paying off debt. There are strong supporters on both sides and both make valid points. Let’s take a look at both ways.
Snowball- With this method you pay off your smallest debts first and work your way up towards your highest debt. The main benefits of this way is you make progress faster and that little extra money you get by paying off of the smallest debts can be used towards the bigger ones. It also gives you more cash flow in case of an emergency or any unexpected expenses.
Highest interest- Interest can be a killer especially if you keep debt for a long time. Paying off the highest interest loans first will save you the most money in the long run especially if you can not do it quickly. Interest is like a silent extra debt payment that you have to factor in. Doing it this way will eliminate that interest and get you closer to principle payments.
What do we here at Cents of Time thing is the best way?- First, we will preface it by saying that doing anything is better than nothing! If you start one of these two methods or do anything to start paying off your debt then you are heading in the right direction. That said, reading books about building habits, positive thinking, motivation, we reside in the snowball camp. Even though the numbers work better paying off the highest interest first, the debt snowball works better psychologically to actually complete paying off your debt. It feels great to get that first debt paid off and your snowball started. That extra money you now make a month can be used to keep paying off more debts, but also gives you more buffer for emergencies. Let’s say you had a debt that was pretty big ($10,000) and it had the highest interest, if you are trying to change your money habits and don’t have a lot to throw at your debt snowball, that $10,000 is going to take a long time to pay off. You might want to give up after trying for so long and are making very little progress. If you paid off a small $300 loan that you were putting $50 towards, now you just raised your income $50 to help pay off the next smallest debt.
What if you have a mortgage or car loan?- Your house most likely has a low interest rate compared to your other debts and you again most likely will not be able to pay it off in less than 5 years. In most cases it is okay to keep the mortgage on your house. You may want to move or downsize to save money for a specified time to help pay off debt if that makes financial and family sense for you. However, you are not supposed to be miserable in this process. It is tough and takes a lot of sacrifice, but that doesn’t mean you need to give up everything to live a debt free life or get out of debt. You will know what you can and cannot do. For renters this could mean the same thing. Maybe it means moving back in with family or friends to help lower the cost of rent to pay for other debts. Whatever thinking you can do to save money is highly encouraged!
Keep or sell the car?- Now car loans are a little more tricky because this is again, another hotly debated topic. Should you or should you not get a car loan? A lot of people consider their car purchase just like a house purchase with a mortgage. It is what it is and it is something that you will carry with you forever. You need a house and you need a car, what difference does it make if there is a payment attached to it? The thing with a house is at least you can justify that the value has a chance to go up or at least stay the same. With a car whether you buy new or used, the value of the car is going down. We are not car experts at Cents of Time, but we would venture to say you can get a pretty good used car for $10,000-$20,000. If you know anything about cars, you might even be able to do a little better. That amount of money is nowhere near what a house payment is so it is very reasonable to say, because I bought a car that was more affordable, I am going to save $200, $300, $400 a month to help pay for the next car or whatever I need to save up for. Remember you income is your greatest wealth building tool, car payments take away from that. Even with interest rates low, that is still money that you are giving away. If you already have a car loan, see how much you can pay down on it and if you can realistically pay it off in 2-3 years. If you can not pay it off in that time frame, you might want to sell it to help free up some extra money to pay off debt and then save up again to buy a better car.
How do you make sure you do not go back into debt?- It takes a mind shift to change your habits and build a different future. The biggest thing we believe in is being content with what you already have. This doesn’t mean you cannot want new things or want something that will make your life easier, it is just being very selective about what you bring in and constantly evaluating what you currently have. Once you start going through the things you already own, you will be shocked at how much of your things you never or rarely use. Here is a little time plug. The more stuff you own, the more time you have to maintain that stuff. If you never had it in the first place or only focused on the things/activities you truly loved, don’t you think you would be smarter with your money and use your time more wisely? It will not be an overnight change either. It will take probably 2-3 years to actually get out of debt, but you still have the rest of your life to make positive decisions. You will still make mistakes and still be learning about what you should and should not spend your money on. The key is to always be heading in the right direction. Saving more and spending less. That is the true key to staying out of debt and building wealth.
We hope this paints a better picture of baby step two. Credit cards are definitely a huge problem for debt, but they aren’t the only thing that contributes to debt and we hope that this article sheds some light on the other parts of debt. Remember, this is for most people the hardest and longest step to accomplish. It requires sacrifice and a changing view of how you are living your life. Deciding to get out of debt and build savings will transform your life for the better. After this baby step, the real fun begins as the next step we are going to start saving for even bigger emergencies and start saving for a house!