Two Methods to Pay Off Your High-Interest Debt
If you’re paying off your debt obligations you are either paying the full balance or making a partial payment (as much as you can), or paying the minimum (if you have too many other debts/expenses to juggle) or you are paying less than or nothing on the minimum payment.
Know This: Interest Rates Influence Your Debt
Anytime you borrow money you have to pay the lender the interest you agreed upon. If you have different sources of debt, chances are they have different interest rates. The higher the interest rate, the more interest you will pay on that debt until it is repaid. Usually general credit cards like VISA or MasterCard charge 19% for example and store cards have a higher rate of interest 25% for example
The more money you put towards interest means you have less money to put towards the actual amount of money you borrowed in the first place. This may be making you feel like you are getting nowhere because your debt never seems to decline very much.
When you have a large amount of existing debt, numerous debts, make minimum payments, or miss payments creditors may see you as a credit risk and unilaterally increase the rate.
Where Most Interest Rates Come From
Generally, higher interest loans relate to unsecured loans. Unsecured debt often includes credit sources like credit cards and payday loans. Unlike a mortgage or auto loan, these types of debt are not secured by tangible assets like a house or car.
While a mortgage might have an interest rate of around 3% depending on the terms, credit cards can have an interest rate of up to 29.99%. The average interest rate on credit cards is 19%, meaning you pay that on any outstanding balance.
Payday loans have even higher rates of interest. The maximum allowable interest rate in Canada is 60%, but payday loans are exempt from this. Payday loans are regulated by each province. In Alberta, the maximum allowable interest rate on payday loans is $15 for every $100 borrowed. This might not sound like much, but depending on how long you are borrowing the money. Many times there is a transaction fee plus an interest charge for a two week loan. When calculated on an annualized basis, these charges could amount to as much as 750% if you continue to roll the loan over every two weeks.
1. The Avalanche Payment Method of Paying Down Loans
The Avalanche method is based on paying off those debts with the highest interest rate first. Essentially, you start by only making minimum payments on all debts except for the one with the highest interest rate. Put as much money as you can towards your highest-interest debt until it is repaid.
By paying off debt with the highest interest rate first, more of your money will go towards the actual debt you owe. This method may also prevent you from spreading your debt repayment budget too thin. If you spread your money out between too many debts, you may run the risk of taking many years to retire the debt.
Should surplus funds come your way be sure to use the funds toward further debt repayment too.
2. The Snowball Payment Method
As always, the best way to stay on top of credit is to pay, in full, each month, the required payment on all loans/credit. Not paying anything, like missing payments will certainly demonstrate to the lender that you are a risk and your interest rates may rise. Obviously this is not what you want.
The Snowball method of paying down debt is the opposite of the avalanche method. This means you pay off the lowest outstanding balance first based on your particular circumstances.
1. You continue to pay the minimum or more, if you can, on each loan and always pay on time.
2. You pay more than the minimum monthly payment on the lowest individual debt. This way you will get this debt off your back sooner and reduce the overwhelming anxiety that comes from having too many creditors.
3. Next you pay extra on the next highest individual debt and pay it down as quickly as possible while paying the minimum on your other debts.
4. Any windfall that comes your way, use it to pay off as many of your debts as possible right away.
Pick What Works for You!
Both methods may help you based on your style and motivation to gain momentum and eliminate the stress of debt overload with ever-increasing interest amounts.
If you’re unsure about how to manage your high-interest debt or are in a panic because more loans, bills and creditor actions are not the solution to your debt issues contact one of our ‘Debt Solutions People’®.
Our Licensed Insolvency Trustees are ready to help you switch your debt problems into debt solutions starting with a free consultation.