The Blessing and Curse of the Credit Card
One of the most used (and abused) forms of debt finance is the credit card. Credit card debt finance is not necessarily a bad form of debt in and of itself. Still, its ease of use and widespread availability, combined with the high-pressure sales tactics of many credit card companies can be a hard-to-resist combination for many small business owners. And there may be periods in a business or individual’s life when piling on the credit card debt is simply the only way to get through a challenging phase: loans may not be available, and the savings account may be empty.
However, it takes real discipline on the part of the consumer to reverse course and get back on track financially after such periods.
Gaining Control Over Debt
Luckily, simple tools are available to help individuals map out repayment amounts and timelines, regain a sense of control over their finances, and see an end-date when they will be debt-free.
Two of the most popular repayment strategies, popularized by the personal finance guru Dave Ramsay, are called the “Debt Snowball” and the “Debt Avalanche”. These strategies can be applied to any kind of debt – credit cards, consumer loans, student loans, etc.
Debt Snowball Repayment Strategy
In this approach, the consumer specifically targets repaying the debts with the smallest balances owed first, while maintaining minimum payments on the larger balances.
This has an important psychological component of seeing the number of debt accounts or credit card bills lessen as the balances get sequentially paid off. However, this approach does not take into account the relative interest rates of each card or debt product so it could cost more than the avalanche approach in the long run.
Debt Avalanche Repayment Strategy
In this approach, the consumer targets repaying the highest interest debts or credit cards first, while paying minimums on other balances.
While this may work out to be a more economical strategy, the consumer will not get early satisfaction (and motivation) from seeing debt balances paid off like they would with the snowball method.
Debt Repayment Example
To illustrate these strategies, lets say Jane Wevie has the following debts outstanding:
|Description||Amount||Interest Rate||Minimum Monthly Payment
|Credit Card A||$4,300||16%||$86
|Credit Card B||$758||19%||$17
|Student Loan C||$12,850||7%||$78
|Consumer Loan D||$1,300||23%||$65
Jane has decided to allocate $400/month to repaying debt.
With the Debt Snowball method, the extra $164/month would be systematically applied to:
- Paying off Credit Card B (in 5 months’ time),
- Then paying off Consumer Loan D (in 10 months’ time),
- Then paying off Credit Card A (in 24 months’ time), and
- Finally, paying off Student Loan C (in 60 months’ time).
If the Debt Avalanche method was applied, the extra $164/month would be used to:
- Pay off Consumer Loan D first (in 7 months’ time),
- Then pay off Credit Card B (in 10 months’ time),
- Then pay off Credit Card A (in 24 months’ time), and
- Finally, pay off Student Loan C (in 60 months’ time).
In this example, the difference in interest rate from applying the strategies is marginal (less than $50), and it very much comes down to personal preference.
A variety of free products available online can help you model the different repayment strategies for your debt. Vertex42’s Debt Reduction Calculator is particularly straightforward and easy to understand.
Getting Out of Debt
Paying down debt can take discipline and hard work but with persistence and consistency, you can create new habits that will leave you feeling more in control and financially strong.
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