Regardless of whose advice you’re listening to while on your journey toward financial independence, one item that finds its way to the top of nearly every list is eradicating debt, especially consumer debt. In most cases, consumer debt is slowing your progress toward financial independence by delaying repayment, encouraging you to live above your means, and incurring additional interest charges along the way. I’m very excited to report that, except for our mortgage, Nicole and I are officially consumer debt-free!
Last week, we made our final car payment for Nicole’s vehicle! That means the number of creditors we owe shrunk from two to one, leaving just our mortgage lender. No longer having to make that car payment will free up $200 in our budget each month! As I mentioned in last week’s blog post, to reach our annual goal of $10,000 in dividend income in 2021 we are going to need to drastically increase the amount we invest each month. As nice as it would be to throw that $200 into our vacation sinking fund each month, that’s probably not a realistic option at the moment.
What is Consumer Debt?
In general, consumer debt includes items like credit card debts, student loans, vehicle loans, mortgages, and other personal borrowings. When you take out a loan for that new car you’ve been eyeing or when you put a new pair of shoes on your credit card, you’re incurring additional consumer debt. Since business-related and investment-related debts are used to generate income they don’t typically fall under the consumer debt umbrella.
For those of you thinking it, I agree that there are various situations where using debt can be a good decision, even for some types of consumer debts. For some examples of those scenarios, check out this previous post about using debt to your advantage.
How We Avoided Consumer Debt
I firmly believe that the easiest path to zero consumer debt is by not taking on consumer debt in the first place. It might not be the answer you want to hear, but it’s true.
Nicole and I have always been very attentive when it comes to consumer debt. We don’t purchase designer brands or have an extravagant lifestyle. We save restaurants for special occasions and opt to eat most of our meals at home. Most importantly, we stick to our budget to ensure we live below our means in other areas too.
Apart from Nicole’s recently-paid-off vehicle, neither of us had ever taken out a loan to buy a car. I’m still cruising around in a rusty 2003 Buick and I will be for the foreseeable future. We have been diligent users of our credit cards and essentially treat them like debit cards, only buying what we can truly afford (we prefer credit cards to debit cards simply because of the bonuses, benefits, and security they offer).
Both of us were fortunate enough to graduate from college completely debt-free. I received very generous scholarships from both the community I grew up in and the college I attended. I was also able to get room and board covered for three semesters by working for univesity housing. Nicole’s parents did an incredible job saving for her college education throughout her life. By the time Nicole was ready to attend college, the amount in her college savings plan was enough to cover all four years of her expenses.
What’s the Best Way to Pay Off Your Consumer Debts?
If I’ve said it once, I’ve said it a dozen times: create a budget and follow it. There is no work-around when it comes to paying off debt. Debts don’t just go away after leaving them alone for a period of time: they get bigger. You simply have to assign a portion of each month’s earnings to be used to pay off the debt. The more money you throw at the principal on a monthly basis, the more quickly you’ll pay off the debt and the less you’ll pay in interest. The process alone of creating a budget helps you identify where your priorities lie and how that compares to your intentions.
I believe having a budget is so important, I dedicated an entire blog post outlining how to build your own budget.
In What Order Should I Pay Off My Consumer Debt?
There are essentially two different philosophies when it comes to paying off consumer debt. They are often referred to as the debt snowball method and the debt avalanche method, both of which are terms that Dave Ramsey has helped popularize over time.
The first two steps are the same for each method:
- Make a list of all of your outstanding debts (include the outstanding balance and the interest rate for each)
- Make minimum payments on all of your debts except one
Notice how Step 2 specifically notes that you shouldn’t be making minimum payments on one of your debts? That’s because you’re going to tackle one debt at a time until you’ve eliminated all of them. You can choose one of the debt payoff methods below to help you identify which debt you’d prefer to start paying off first.
Debt Snowball Method
With the debt snowball method, you would start by sending extra payments to the debt with the lowest balance first. After that debt is paid off, you would then move your attention to the debt with the next lowest balance. You continue to follow that process until all of your debts have been paid off!
The debt snowball method is designed to help you build confidence on your debt-free journey. Staring down a five or six-digit debt can be intimidating and, quite frankly, be a big deterrent from taking the first step. The debt snowball method acknowledges that fact and helps you build momentum as you pay off your debts, just like a snowball rolling downhill.
Debt Avalanche Method
With the debt avalanche method, you would first send your extra payments to the debt with the highest interest rate. After paying off that debt, you would focus your energy on the debt with the next highest interest rate. Again, you repeat that process until all of your debts have been paid off!
The debt avalanche method might not have the psychological advantages that the debt snowball method does, but it does enable you to reduce your interest cost comparatively. If you are strong-willed and focused on the “dollars and sense,” then the debt avalanche method might be for you (this is our method of choice).
Making Your Decision
When deciding which debt to start paying off first, the choice is totally up to you. Some people feel that the debt snowball method works well for them because it helps build momentum easily and provides a big psychological boost. Others prefer the debt avalanche method because it results in the greatest amount of interest savings.
Don’t let someone else try to convince you that their method is the “right” way to do it. Personal finance is personal; it’s ultimately up to your discretion how you want to handle it.
For those of you in the process of paying down debt, what questions do you have?
If you’ve paid off a large amount of debt yourself, what tips do you have for those that are currently in the process of chipping away at theirs?
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