Looking to Paydown Debt?
Debt is something people usually aim to avoid. But, in reality, it’s a lot more common than you might think. In fact, American households carry over $17.2 trillion in combined debt. To break that down, the average household debt is roughly $103,000 as of 2023. This can include many different types of loans, such as mortgages, car loans, student loans, credit cards and more.
In this article we’ll share three strategies for paying down debt. We’ll also discuss the pros and cons of debt consolidation and whether it may be right for you.
3 Ways to Pay Down Debt
As with any financial goal, it’s important to have a plan. Generally, there are three pay-down strategies you can consider:
- Snowball: This approach pays off your lowest balance first. Not only does this method provide a quick win that’ll give you a sense of accomplishment, but your available funds will “snowball” with each account paid off — hence the name. Eventually, you’ll be able to pay more each month toward your larger balances, making it easier to pay them down.
- Avalanche: This strategy works by focusing on the account with the highest interest rate first, increasing the amount paid toward principal over time. This is especially helpful if you don’t have any small-balance accounts, but do have one with a high interest rate. Mathematically, it’s considered more efficient and cost-effective than the snowball method.
- Consolidation: Lastly, you can consolidate your debt. Simply put, that means combining all outstanding balances into one new loan or line of credit — ideally, at a reduced rate.
Consolidation 101
Consolidating debt into one monthly payment can be a more convenient alternative to juggling multiple payments simultaneously. And you may be able to reduce the interest rate on your debts. Consider a few statistics, as recently reported by U.S. News & World Report:
- Nearly 70% of borrowers say their finances have improved since consolidating their debt. Among them, half are less worried about affording their payments, while 37% say they put more income into savings.
- Over a third (36%) of borrowers have improved their credit scores after debt consolidation. However, you should be aware, consolidating balances and closing multiple credit card accounts could cause your credit utilization rate to rise, possibly hurting your score.
- The top reason borrowers consolidated their debt was to pay it off faster. 21% did so to simplify debt management and 20% did so to lower their monthly bills.
However, there are some things to consider with this approach. First, you may pay more total interest in the long run, especially if you extend the term of your debt. Missing a single payment could also more negatively impact your credit score. You may also hurt your score if you run up credit card balances again or close your paid-off accounts. There may also be costs such as origination fees, balance transfer fees, closing costs and annual fees to consider.
Example of debt consolidation
Let’s say you have four credit cards and owe a total of $25,000, all with a 20.99% interest rate. You’d have to pay roughly $1,265 per month to pay them off in two years. By then you’d have paid over $5,000 in interest.
When Should You Consolidate Debt?
Consolidation may be a good idea if you have high-interest accounts. However, if your credit score isn’t high enough to qualify for a lower rate, it may not make sense to pursue this option.
Keep in mind that consolidation isn’t a cure-all for your financial situation. It doesn’t address underlying issues that may contribute to financial hardship, such as overspending and other behaviors. So, take your time and consider all the variables before deciding on a repayment plan.
This content is for informational purposes only. It is not designed or intended to provide financial, tax, legal, investment, accounting, or other professional advice since such advice always requires consideration of individual circumstances. Please consult with the professionals of your choice to discuss your situation.