If you read the first post on high-interest debt, you know how bad high-interest debt truly is. It can wreak havoc on your overall financial picture not only by offsetting or overtaking your investment gains, but also by preventing your investments from growing as much they could have, had you not had to pay off the high-interest debt (both principal and interest).
Given how detrimental that high-interest debt is to trying to grow your investments, I emphasized in the previous post that you should try to eliminate it as quickly as possible. If you just leave it sitting there–even not adding to it at all–and make the minimum payments on it each month, you’ll never be able to get anywhere with your investments and reach your financial goals.
Perhaps you find yourself in a situation in which you do indeed have some high-interest debt, and now you want to eliminate it as quickly as possible. After reading, you’ve determined that it’s just too devastating to leave it there, and you want to be in a position to benefit from investing.
Thankfully, you’ve realized that by carrying high-interest debt, anything you’re doing on the saving and investment side likely isn’t actually accomplishing anything, because it’s being more than offset by the high-interest debt.
You’ve also understood that the longer you hold high-interest debt, the more you’re going to pay in interest over the long term, which means the less money you have available to save, both for the continuation of your emergency fund beyond $1,500 and for additions to your retirement account(s).
But what are the best methods to eliminate your high-interest debt?
A Word on Dave Ramsey
I’ll state upfront that Dave Ramsey is the king of “getting out of debt” advice, and you probably already know that. His programs have helped tens of thousands of people get out of debt and stay out of debt, so this is one route you might consider.
Does that mean I’m recommending that you purchase one of his products to help you get out of your high-interest debt? No, not necessarily. But I feel I would be negligent if I didn’t tell you about his programs for getting out of debt, as I know they have been beneficial to so many.
Now let me say something very important here: Me telling you about potentially using a Dave Ramsey program for getting out of debt comes with a major caveat. The caveat is that as good as Ramsey is at helping people eliminate debt as quickly as possible, you should ignore literally everything he says about investing.
Do not follow Dave Ramsey’s investing advice. Ever.
Others and I are well aware of the errors in his investing advice, have publicly pointed them out to him on Twitter and on Facebook, and he has blocked all of us as a result. If that raises a big red flag for you, it should. Why would a prominent financial guru go to the trouble to block anyone who points out factual errors in his investing advice?
I’m not trying to color your views on Dave Ramsey’s materials on getting out of debt by telling you that, but it’s the truth. Ramsey won’t have any legitimate criticism of his investing advice, and it is most likely because he makes a lot of money on such advice through commissions that make their way up the chain back to him through the financial partners that he directs his followers to.
Ignore his investing advice. Following it will end up costing you a lot of money, both in investment fees, and in the behavioral errors that will result from you learning things from him that are provably false. What are these things? I’ll probably do a blog post in the future on them, so be on the lookout for that.
You might be thinking to yourself, “But why should I trust you on this, Mr. No-Name Investing Blogger, when Ramsey has a successful financial advice business, radio show, podcast, conferences, etc.?” That’s a fair question.
Here’s the answer: If you have even the slightest ability to search things capably on Google, you’ll easily find some of the other people Dave Ramsey has blocked on social media over questioning his investing advice.
And I’m not talking just general finance bloggers. I’m also talking financial analysts and academics who teach finance at universities.
Don’t want to take my word for it on Ramsey’s investing advice? You’ll find plenty of others who agree with me, I assure you, even if you may not yet fully understand everything they say (depending on your level of financial literacy).
But again, am I telling you that you shouldn’t seek Dave Ramsey’s materials for getting out of debt? No, not at all–his help there is very good, so if you decide to go that route, I expect you’ll find it beneficial.
Back to Eliminating High-Interest Debt
So the Ramsey option is one option for how to go about eliminating your high-interest debt. The other option is to go with basically a boiled-down version of what Ramsey generally teaches, which are some universal debt-elimination principles, some form of which you’ll find in a variety of different venues (i.e., these are not unique to Dave Ramsey). Here are what I would consider them to be:
- Have at least $1,500 in a starter emergency fund. No surprise there if you’ve already read everything on the blog to this point.
- Make lifestyle alterations down to essential expenses in order to free up cash to pay off high-interest debt aggressively. In other words, you make the hard cuts to things you have to until you reach the point that you have eliminated all high-interest debt. Naturally, the faster you eliminate the debt, the shorter this period of living at just the essential level will be.
This is similar to what I recommended in the “Emergency Fund FAQs” post when discussing ways to build your emergency fund to its initial $1,500 target, albeit a longer period in this instance in which you might have to make these cuts until your high-interest debt is completely eliminated.
Getting your emergency fund to $1,500 following that strategy hopefully wouldn’t take too long. Eliminating your high-interest debt, depending on how much it is, will probably take significantly longer. - Aggressively pay off your high-interest debt using one of the two methods I discuss below. By “aggressively,” I mean literally funneling every dollar that isn’t going to basic living expenses toward making payments on the debt.
Think of it like this: You find a $10 bill in the pocket of a shirt you haven’t worn in months, and the first thought that goes through your mind when you hold it in your hand is, “Well, that’s $10 more toward the credit card debt this month.” That type of mentality is what you need.
With all of the above in consideration, here are the two main methods of paying down high-interest debt you’ll see most often across the personal finance universe.
Method #1: The “Snowball” Method
The snowball method essentially has you pay off the high-interest debt with the smallest balance first, progressively working your way toward the debt with the highest balance. The idea behind the snowball method is that you build momentum as you go, which can be highly motivating.
For example, over time you focus on paying off a credit card with a $1,000 balance (while making minimum monthly payments on all other debt), and with that debt now gone and no longer a burden on you, you feel even more empowered to tackle your next highest-amount debt, which is a credit card with a balance of $3,000.
Then after that, you move to your next highest debt, which is another credit card, this one with a $4,000 balance. You get the idea: The more debt you eliminate, the greater the motivation to tackle your debt with higher balances.
For the record, the snowball method is what you’ll see Dave Ramsey usually advocate. Ramsey believes that systematically paying off one debt at a time from lowest to highest is a powerful motivator that should be employed to one’s advantage.
Method #2: The Mathematically Optimal Method
If the snowball method relies on personal motivation, the mathematically optimal method relies on, well, math. The key factor to remember here is that while the snowball method is highly motivating, it technically is not mathematically optimal. What do I mean?
If you go with the snowball method, over the entirety of the period in which you are paying off high-interest debt, you will end up paying more money toward your debt than if you did the mathematically optimal method. This is because the key principle of the mathematically optimal method is to pay off the debt with the highest interest rate first (while making minimum monthly payments on all other debt), regardless of the size of the balance.
Doing so ensures that when your total debt across all accounts is in the picture, you will, in fact, pay the least in interest that you have to. Rather than letting the highest-interest debt sit there and compound further while you deal with lowest-balance accounts first, you instead look at all of your debt accounts, find the accounts with the highest interest, and tackle them first.
The mathematically optimal method, then, is the method that ensures that when all is said and done, and all high-interest debt is eliminated, you will have paid the least amount of money required to eliminate the debt because you paid less in interest over the entire period that it took to eliminate it.
The concern that Dave Ramsey has with the mathematically optimal method is that if the balance is high on the highest-interest debt you are trying to eliminate first, you might get discouraged by continuing to pay and pay, only to still have a balance after a lengthy period. Ramsey is concerned that you will think in such a situation, “What’s the point,” and then quit trying to eliminate the debt because you’re so discouraged at how long it’s taking to do so.
I don’t necessarily disagree that Ramsey’s concern is valid, but it’s also a behavioral one, which means that it may apply to some and not others. Only you know your personality and your own tendencies, so only you can decide which of the two methods is the best for you.
But the truth is that purely mathematically, the numbers don’t lie: You’ll save more money with the mathematically optimal method, if you have what it takes to pull it off.
Do you think you might get too discouraged using the mathematically optimal method if you have yet to pay off a high-interest debt balance fully within a certain period and then be tempted to quit? If so, perhaps you should go with the snowball method.
Get It Done, No Matter Which Method You Choose
Whichever method you choose to implement in order to eliminate your high-interest debt, the point is to eliminate it fully and then stay out of high-interest debt. Permanently. Only then will you be in a position to begin investing seriously (and simultaneously continue building your emergency fund to the 3-6 months’ worth of basic living expenses level).
Again, the bottom line is recognizing just how much damage high-interest debt does to your overall financial picture (both now, and what it is already doing to your financial future), getting serious about eliminating it as quickly as possible, determining a plan, and then implementing that plan.
You can do it. If you’re serious about your financial future and the goal of having a financially secure retirement, you can do it. Don’t let yourself think that you don’t have what it takes to get it done. Let your financial goals drive your motivation to eliminate your high-interest debt and put yourself in a position to benefit from investing.
Next time: High-interest debt FAQs.