Now that we’ve got the ball rolling by evaluating where we are and lowering those interest rates, next step is prioritizing the list of debts. The most effective way to tackle your debts is to make the minimum payment on all your debts and then put everything extra onto one debt until it’s gone. Then you move on to the next debt, focusing your money there until its gone and so on and so on.
There are two different schools of thought on how to prioritize these debts and then there’s my plan. Either of these three will work just as well, so don’t stress too much over this. Just pick an order that makes the most sense to you.
- Start with the highest interest debt. This option makes the most sense mathematically and will save you the most money in interest
- Start with your lowest balance debt. The logic behind this method is human psychology. The idea being that knocking a debt off your list as quick as possible will fuel your motivation to keep going.
- Then there is me, who’s a bit of a free-spirit. I say pick the order using your own judgement. Both saving money on interest and keeping motivated are very important factors in deciding which debt to tackle first. There are other facts to consider, such as:
- Super high interest loans that you can’t lower, should always be first. Things like payday loans need to be wiped out as fast as possible. The interest rates on those are so high that the only way to ever get it paid off is to work your butt off to pay them out asap!
- Sometimes the amount of the minimum payment per month is stressing you out, so you can start with that debt if you like. This can be especially useful if you’re self-employed or your income varies from month to month. Getting rid of the biggest monthly payment can make it easier to manage the minimums on the others if you have a very low income month.
- You may have a loan to a family member or friend that is not charging any interest, but to repair the strain on that relationship, you may choose to start with that debt anyway
- Whether or not a loan is callable (the lender can demand their money from you now) may also be a factor in your decision
- You may even want to sort them by type of debt. So do credit cards first, then lines of credit, then student loans for example.
The bottom line is that these are your debts and you get to choose which ones you want to ditch first. So with all these factors in mind, grab your list of debts and number them 1-finish so you now have a plan of attack.
Next we figure out how long until we want to be debt free. As much as we want to say next week, we have to be a bit reasonable in this part. If you owe 40k and you want it gone in a year, be ready for what that means in terms of lifestyle changes to make it happen. I’m all for big goals, but they require big work so be prepared to dig in deep if that’s the goal. I’m here for it if that’s your plan and that is totally my speed. I also recognize that that level of intensity isn’t for everyone, so choose your comfort level. Know that the longer you take, the more money goes down the drain for interest, but at the same time if you’ve never even thought of being rid of it, paying interest for three years vs for life is a way better option. No right or wrong, just what you are willing to change to get the goal.
Most people tend to do their budget and fit in what’s left over for debt. This approach may get you some progress if you’re working hard on cutting expenses or making more. It does tend to make your debt repayment amount variable and easy to trim first when things pop up. Picking the deadline first gives you a monthly amount. This amount becomes fixed in the budget and other things fall around it to make room. We want debt repayment to become non-negotiable, not just something we fit in if or when there’s extra. This is how we make sure it gets gone. Here is a calculator to help come up with what the monthly payment needs to be for the timeframe https://www.debt.ca/calculators/debt-repayment-calculator
With our new debt repayment plan, a solid budget and knowledge of your finances becomes essential here. I can’t tell you how often I would set about paying off debt. I’d do the timeline, do the math to figure out the payments, make my pretty spreadsheets (I love making spreadsheets), even make the payments.. all while not paying attention to the rest of the picture, particularly the part where these extra payments were forcing me to use credit again because I was running out of money.
The spending analysis and budget are how you know your money habits up close. If you decide to spend more on repaying debt, that money has to come from somewhere, namely cutting spending or earning more. Doing all this work to know your debt and making a plan to get rid of it, is a complete waste of time if it’s not also followed up with changes in spending or earning or both. It seems obvious, but I am 100% certain I am not the only person who has done the pen and paper work of figuring out debt or the extra payments on debt without doing the habit changing work of dealing with debt.
Now we have a solid plan for how much we need to repay every month to get it gone in our chosen timeframe, next we’ll work on the habits and places our money isn’t working to bring us towards this goal and of course the beautiful thing that brings it all together.. the budget! Stay tuned.
Lots of love
Dawn
Tax Wise 