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Debt-payoffs

Aunt Spiker

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There are several methods to paying off debt. They all start with the same idea: you gather your information for each bit of debt, calculate up your monthly budget, figure out how much you can apply to your debt-reduction each month. . . after that a few different options come into play. Which method would you choose/ have you done/ do you feel someone should follow?

Various methods to follow:

1) Credit Cards only: using same mount of $ towards each card regardless of interest rate (aka - $30.00 per card) Not *minimum payment* but affordably above it. Results in a slow reduction each month on all amounts.

2) Credit Cards only: Pay off lowest-amount owed first regardless of interest, then pay off remaining amounts from high interest to low interest.

3) Credit Cards only: Pay-off max amount of $ possible to highest-interest card first, regardless of amount owed, while paying minimum towards other cards. As you pay off cards your pay-off max amount increases by the following card's old minimum payment as you free up debt - aka - you will always put the same amount of $ towards debt-reduction.

4) Any of the above methods - but then take your max-payoff amount each month and add that to your auto/school/mortgage to pay it down. This would mean paying above minimum (towards principle, not escrow or interest - if you can option this)
 

justabubba

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it varies from situation to situation, but assuming all loans are current and there is nothing in particular you are trying to do other than maximize the use of your surplus dollars to pay down existing debt, then pay off the highest interest rate loans first
that excludes any loans you have incurred using the rule of 78s ... which unscrupulous but legal calculation is frequently used to prey on old people prepaying funeral expenses (the interest is front end loaded and substantially paid first in those transactions, so there is no benefit to prepaying a rule of 78s loan)
i am guessing your credit cards will have the highest interest rates
keep all current but prepay the one with the highest interest rate first (your #3)
then eliminate the other lower interest loans in descending order
if your home mortgage interest paid is written off against your taxes*, unless it is a high rate, you want to save it for last. if you take the standard deduction on your tax return then it doesn't matter ... if its rate is higher than other loans pay its principal first
*once you have banked six months income, then start prepaying the mortgage

when you make payments above what is due always record "apply interest first balance IOM". Inverse Order of Maturity application causes the principal to be paid rather than having your surplus amount applied as prepaid interest

when making major purchases, carry cash ... not a credit card or debit card but cash. most retailers will significantly discount their sales for cash buyers. not only do they save the 3% transaction fee to accept plastic but the cash sale might not show up on their operating statement. i routinely get 30-40% off furniture purchases only because i ask them what their CASH price is. my mechanic, dentist, guitar and amp techs give me great rates and great service because i always pay in cash

this is an excellent time to hold spare cash. if you do not have much in the bank, use what surplus you do have to hold for an emergency fund before using it to prepay existing but current loans
 

Harry Guerrilla

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There are several methods to paying off debt. They all start with the same idea: you gather your information for each bit of debt, calculate up your monthly budget, figure out how much you can apply to your debt-reduction each month. . . after that a few different options come into play. Which method would you choose/ have you done/ do you feel someone should follow?

Various methods to follow:

1) Credit Cards only: using same mount of $ towards each card regardless of interest rate (aka - $30.00 per card) Not *minimum payment* but affordably above it. Results in a slow reduction each month on all amounts.

2) Credit Cards only: Pay off lowest-amount owed first regardless of interest, then pay off remaining amounts from high interest to low interest.

3) Credit Cards only: Pay-off max amount of $ possible to highest-interest card first, regardless of amount owed, while paying minimum towards other cards. As you pay off cards your pay-off max amount increases by the following card's old minimum payment as you free up debt - aka - you will always put the same amount of $ towards debt-reduction.

4) Any of the above methods - but then take your max-payoff amount each month and add that to your auto/school/mortgage to pay it down. This would mean paying above minimum (towards principle, not escrow or interest - if you can option this)
The most logical, money smart way to do it is to pay the greatest interest card off first, 2nd greatest next etc.
The more psychologically satisfying way is to pay the smallest balance first, then the next smallest and so on.

Of course with both you need to pay the minimum on all the other cards.
 

Kandahar

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The most logical, money smart way to do it is to pay the greatest interest card off first, 2nd greatest next etc.
The more psychologically satisfying way is to pay the smallest balance first, then the next smallest and so on.

Of course with both you need to pay the minimum on all the other cards.
I agree. It depends on the person. If I was in this position, I'd pay the highest interest rate first...but for people who dislike finance or have trouble sticking to plans, I would advise them to pay off SOMETHING (even a lower-interest debt) so that they feel they have accomplished something, which will make them more likely to stick to the plan.
 

Orion

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I have a line of credit and a credit card. The former has very low interest and the other very high. I always pay off the credit card first even if it means just transferring the debt to the line of credit. In general though, I try to avoid using either, but as a student it's not possible right now. To get ahead in life you're going to have debt, unless you started off rich in the first place, and I definitely didn't!

Though I've never used them, debt consolidators are a great service. They condense all of your debt into one monthly payment and convince the banks to give you interest-free status. If you're deep in the hole I would do that. In general though if you can manage your monthly payments it'll be good for your credit rating, so down the road if you get into better financial shape the bank would be much more wiling to give you loans for things like homes, cars, or starting up a business.

I keep in good credit because I have business plans for the future.
 

Harry Guerrilla

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I have a line of credit and a credit card. The former has very low interest and the other very high. I always pay off the credit card first even if it means just transferring the debt to the line of credit. In general though, I try to avoid using either, but as a student it's not possible right now. To get ahead in life you're going to have debt, unless you started off rich in the first place, and I definitely didn't!

Though I've never used them, debt consolidators are a great service. They condense all of your debt into one monthly payment and convince the banks to give you interest-free status. If you're deep in the hole I would do that. In general though if you can manage your monthly payments it'll be good for your credit rating, so down the road if you get into better financial shape the bank would be much more wiling to give you loans for things like homes, cars, or starting up a business.

I keep in good credit because I have business plans for the future.
You have to be careful with debt consolidations.

I invest in 3 and 5 year loans through an online lender, I will never invest into a 5 year debt consolidation loan because many people who do that end up right back in debt in a 2-3 year period.
 

Orion

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They get to keep their credit cards and have the additional debt consolidation loan.
They rack those credit cards right back up again.
Then the root of the problem is their uncontrolled spending habits. Debt consolidators can't do much about that :)
 

tryreading

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There are several methods to paying off debt. They all start with the same idea: you gather your information for each bit of debt, calculate up your monthly budget, figure out how much you can apply to your debt-reduction each month. . . after that a few different options come into play. Which method would you choose/ have you done/ do you feel someone should follow?

Various methods to follow:

1) Credit Cards only: using same mount of $ towards each card regardless of interest rate (aka - $30.00 per card) Not *minimum payment* but affordably above it. Results in a slow reduction each month on all amounts.

2) Credit Cards only: Pay off lowest-amount owed first regardless of interest, then pay off remaining amounts from high interest to low interest.

3) Credit Cards only: Pay-off max amount of $ possible to highest-interest card first, regardless of amount owed, while paying minimum towards other cards. As you pay off cards your pay-off max amount increases by the following card's old minimum payment as you free up debt - aka - you will always put the same amount of $ towards debt-reduction.

4) Any of the above methods - but then take your max-payoff amount each month and add that to your auto/school/mortgage to pay it down. This would mean paying above minimum (towards principle, not escrow or interest - if you can option this)
Number 2 is usually best.
 

reefedjib

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There are several methods to paying off debt. They all start with the same idea: you gather your information for each bit of debt, calculate up your monthly budget, figure out how much you can apply to your debt-reduction each month. . . after that a few different options come into play. Which method would you choose/ have you done/ do you feel someone should follow?

Various methods to follow:

1) Credit Cards only: using same mount of $ towards each card regardless of interest rate (aka - $30.00 per card) Not *minimum payment* but affordably above it. Results in a slow reduction each month on all amounts.

2) Credit Cards only: Pay off lowest-amount owed first regardless of interest, then pay off remaining amounts from high interest to low interest.

3) Credit Cards only: Pay-off max amount of $ possible to highest-interest card first, regardless of amount owed, while paying minimum towards other cards. As you pay off cards your pay-off max amount increases by the following card's old minimum payment as you free up debt - aka - you will always put the same amount of $ towards debt-reduction.

4) Any of the above methods - but then take your max-payoff amount each month and add that to your auto/school/mortgage to pay it down. This would mean paying above minimum (towards principle, not escrow or interest - if you can option this)
Number 2 is best, although I would change it to "Pay off lowest-amount owed first regardless of interest, then pay off remaining amounts from lowest-amount owed to highest-amount owed."

The key to this approach is that you pay minimum payments on all debts, then your budgeted extra payment goes to the lowest amount debt. This eliminates this debt, its minimum payment, and increases the budgeted extra payment quickest. Then you apply your increased budgeted extra payment to the next lowest amount and so on. It is a strategy of debt consolidation. You may pay slightly more in interest since you are consolidating to the account with greatest principle owed, which may or may not be the highest interest. But you are increasing your leverage through the increasing budgeted extra payment.
 
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If you have a lot of self-motivation, then option 3 is the most logical. That will allow you to pay of the debt the soonest. If you fear that you don't have enough motivation, then option 2 would be better because it tends to be the most motivating.

You could try both, first, pay off the lowest balance card, that will likely not be to difficult. You can likely pay off a small balance card in just a few months, with a minimum of effort. If you eat out a lot (like me) then you can easily find an extra $10/day in your budget (I am now eating self made sandwiches for lunch and 59¢ "cup-o-noodles" for lunch) - that's about $300 a month! Most of us who have a lot of credit card debt have at least one card with a max credit limit of $500 or so. Even if it is maxed out you should be able to pay that off in no more than two months.

Then, once you have the confidence that you CAN achieve your goals, start working on your highest interest rate card, even if it has the largest balance. By combining your savings from the minimum payment on the first card, plus whatever extra you were paying on it, plus the minimum payment on the highest interest rate card, you may find that you can pay off your highest interest rate card, even if it is your highest balance card, almost as fast as you paid off the lowest balance card. In my case, the next card I want to pay off has a balance of about $5,000. Paying off the first one and eating out a lot less, plus the min payment on the $5000 card gives me an extra $400/mth to pay on it, which means it will take a little over a year to pay it off. That's a long time for me, so I have some motivation to figure out how to pay it off faster. If I can start working every Saturday and make an extra $100/week, suddenly my $400/mth "debt snowball" increases to $800 per month and I realize that I can have that bad boy paid off by Christmas.

My next card I owe about $4,000 on, and it happens to be the next highest interest rate, and have a min payment of $45. So I take that min payment, add to it the $800 a month extra, and find that it can be paid off in about 5 mths. My next card can be paid off in another 4 mths, then 3 mths, then 2 mths (between me and my wife we have a LOT of credit cards).

Then as you do the same with each sequentially lower interest rate card you will find that you are able to pay off each one faster and faster building more and more motivation as you get to the point that you can see the light at the end of the tunnel.

Of course there may be some oddball exceptions. Like in my case my highest interest rate card has been closed by the bank (I have never been late, the bank just randomly did this a couple of years ago during the banking hysteria). It is also my oldest card. I can no longer use that card, so I prefer to pay down other cards, so that in case of an emergency, I have access to the credit on other cards. I really resent that high interest rate, but it is worth it to me to keep paying interest on it to continue to build my credit (supposedly it actually helps your credit score to have debts that are very old - it proves stability). But by the time I get through paying everything else off (about 3 years), just by making the min payment on that card, and since I can't use it any more, the balance will be down quite a bit. In the end, my "debt snowball" will be well over a thousand dollars (plus my $270/mth min payment) and I will be able to pay that last card off in just a few months like I did most of the rest of 'em.

Also, if one of your goals of paying off credit cards is to improve your credit score, then there may be an alternative approach. High balances on credit cards really hurt your score. Because of my high balances, my credit score is a little below average (mid 600's), but my credit score should be well above average. I have over 20 years of perfect credit reflected on my credit report, and a fairly large amount of credit and a lot of perfectly paid off accounts. My problem is my high credit card balances. Credit card balances that are maxed out or close to maxed out (like 90%) hurt your credit much more than credit card balances that are lower (regardless of the total debt/credit limit ratio). So if rapidly improving your credit score is a main objective, then you may want to try paying down each card, from smallest to largest, to just below 90% before you go for paying off cards. About 5 years ago, when I was looking into getting a commercial construction loan, I was able to increase my credit score (it went from the upper 500's to nearly 700) by nearly 100 pts primarily by manipulating the structure of my debt.

By the way, during my lifetime I have borrowed and repaid several million dollars, but at no point since the age of 19 have I been debt free.
 
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