Debt Repayment: Doing the Math

paper in a clipboard that has repayment plan written on it with a pencil on top of it.

Debt repayment is one of the most important outcomes of the financial literacy we offer. The most pernicious kind of debt most of us face is credit card debt—it’s easy to acquire too much of it, and it often takes decades to pay off. That’s why paying off debt has to be a focused and careful strategy.

When you’re working to eliminate debt, you have to do some planning. Without a good strategy, it can take much longer, and you will spend so much in interest charges that it can result in paying an astronomical amount for a minimal-cost item.

Debt repayment strategies:  

Debt Snowball. You’ve probably heard of the debt snowball method before. With this strategy, you start by paying the minimum required to all of your debts every month. Then, take any leftover money you can put toward debt repayment, and apply it all toward the debt with the smallest balance.

Deeper math. We’re going to digress into the math of the snowball method here. Skip this next part if it makes your eyes glaze over, but we live for this stuff.

A big caveat; the numbers in the next section are approximations. Everything is rounded up and roughly figured, so this isn’t precisely what a debt payoff scheme would look like. It’s just an example of how the debt snowball works to remove debt.

Let’s say you have 4 credit cards with balances you’re trying to pay off. You owe $500 to one, $1000 to the next, $2000 to the next, and $3000 to the last card. This puts your total credit card debt at $6500, roughly around the national average.  

Let’s say you have $300 to put toward credit card bills every month. With a minimum monthly payment of 4% of the balance, the minimum payments for cards 1 through 4 start at $20, $40, $80, and $120. That’s $260. So how do you split up the remaining $40?

With the debt snowball method, you put all the extra toward the $500 balance. That debt will shrink faster month-after-month until it’s eliminated.

Also, by putting this extra toward the lowest debt, you’d pay it off in 7 months, while if you only paid the minimum, it would take 43 months.

Here’s roughly what your debts look like month after month, considering interest rates around the national average of 16%.

Debt Snowball, month by month

Month 1, $300 total payment  

As you carry debt month-to-month, interest is added. Paying $60 toward your $500 balance brings the total owed to $440, but with interest accrued, you end up owing $447 the next month.

    Debt 1: $500 – $20 minimum payment – $40 extra =$447; Debt 2: $1000 – $40 minimum payment =$973; Debt 3: $2000 – $80 minimum payment =$1947; Debt 4: $3000 – $120 minimum payment =$2920

Month 2, $300 total payment  

You’ll see in month 2 all of the minimum payments go down, because they’re based on a percentage of the balance owed.

    Debt 1: $447 – $18 minimum payment – $48 extra =$387; Debt 2: $973 – $39 minimum payment =$947; Debt 3: $1947 – $78 minimum payment =$1895; Debt 4: $2920 – $117 minimum payment =$2842  

 Month 3, $300 total payment  

    Debt 1: $387 – $15 minimum payment – $57 extra =$320; Debt 2: $947 – $38 minimum payment =$922; Debt 3: $1895 – $76 minimum payment =$1844; Debt 4: $2842 – $114 minimum payment =$2766  

Month 4, $300 total payment  

We’re keeping the smallest minimum payment at $15, as credit card typically have a base minimum payment of $15-20 or so, no matter how low the balance gets.

    Debt 1: $ 320 – $15 minimum payment – $64 extra =$245; Debt 2: $922 – $36 minimum payment =$898; Debt 3: $1844 – $74 minimum payment =$1795; Debt 4: $2766 – $111 minimum payment =$2693  

Month 5, $300 total payment  

    Debt 1: $245 – $15 minimum payment – $70 extra =$163; Debt 2: $898 – $35 minimum payment =$874; Debt 3: $1795 – $72 minimum payment =$1747; Debt 4: $2693 – $108 minimum payment =$2621  

Month 6, $300 total payment  

    Debt 1: $ 163 – $15 minimum payment – $76 extra =$74; Debt 2: $874 – $34 minimum payment =$850; Debt 3: $1747 – $70 minimum payment =$1701; Debt 4: $2621 – $105 minimum payment =$2551  

Month 7, $300 total payment  

Now after 6 months, the first debt gets paid off, and there’s a little extra to apply to the next smallest debt.

    Debt 1: $74 – $15 minimum payment – $59 extra =$0; Debt 2: $850 – $34 minimum payment -$22 extra=$805; Debt 3: $1701 – $68 minimum payment =$1655; Debt 4: $2551 – $102 minimum payment =$2483  

Month 8, $300 total payment  

This month, we’re putting all the extra aside from minimums toward Debt 2. Debt 1 is completely gone, so payoff will really accelerate.

    Debt 1: $0; Debt 2: $805 – $32 minimum payment -$103 extra=$680; Debt 3: $1655 – $66 minimum payment =$1611; Debt 4: $2483 – $99 minimum payment =$2417  

Month 9, $300 total payment  

    Debt 1: $0; Debt 2: $680 – $27 minimum payment -$112 extra=$550; Debt 3: $1611 – $64 minimum payment =$1568; Debt 4: $2417 – $97 minimum payment =$2352  

Month 10, $300 total payment  

    Debt 1: $0; Debt 2: $550 – $22 minimum payment -$121 extra=$414; Debt 3: $1611 – $63 minimum payment =$1568; Debt 4: $2352 – $94 minimum payment =$2289  

Month 11, $300 total payment  

    Debt 1: $0; Debt 2: $414 – $17 minimum payment -$128 extra=$274; Debt 3: $1568 – $63 minimum payment =$1526; Debt 4: $2289 – $92 minimum payment =$2228  

Month 12, $300 total payment  

    Debt 1: $0; Debt 2: $274 – $15 minimum payment -$135 extra=$128; Debt 3: $1526 – $61 minimum payment =$1486; Debt 4: $2289 – $89 minimum payment =$2169  

Month 13, $300 total payment  

Less than 6 months after paying off Debt 1, Debt 2 is now paid off, even though it was twice as large when we started. Things have already begun to SNOWBALL…

    Debt 1: $0; Debt 2: $128 – $15 minimum payment -$113 extra=$0; Debt 3: $1486 – $59 minimum payment -$26 extra=$1420; Debt 4: $2169 – $87 minimum payment =$2111  

Month 14, $300 total payment  

Now more than half of our total monthly payment amount is going toward the debt with the smallest balance. We’ve knocked out 2 of our 4 total balances, so it feels like we’re halfway there, even though we’ve only paid off the 2 smallest balances of the 4 we started with.

    Debt 1: $0; Debt 2: $0; Debt 3: $1420 – $57 minimum payment -$156 extra=$1226; Debt 4: $2111 – $84 minimum payment =$2055  

Month 15, $300 total payment  

    Debt 1: $0; Debt 2: $0; Debt 3: $1226 – $49 minimum payment -$169 extra=$1024; Debt 4: $2055 – $82 minimum payment =$2000  

Month 16, $300 total payment  

    Debt 1: $0; Debt 2: $0; Debt 3: $1024 – $41 minimum payment -$179 extra=$818; Debt 4: $2000 – $80 minimum payment =$1947  

Month 17, $300 total payment  

    Debt 1: $0; Debt 2: $0; Debt 3: $818 – $33 minimum payment -$189 extra=$607; Debt 4: $1947 – $78 minimum payment =$1895  

Month 18, $300 total payment  

    Debt 1: $0; Debt 2: $0; Debt 3: $607 – $24 minimum payment -$200 extra=$391; Debt 4: $1895 – $76 minimum payment =$1844  

Month 19, $300 total payment  

    Debt 1: $0; Debt 2: $0; Debt 3: $391 – $16 minimum payment -$210 extra=$170; Debt 4: $1844 – $74 minimum payment =$1795  

Month 20, $300 total payment  

We’ve paid off another debt now, around 7 months after paying off Debt 2. There’s only one debt left! And again, we really feel momentum building as we score another ‘win’.

    Debt 1: $0; Debt 2: $0; Debt 3: $170 – $15 minimum payment -$155 extra=$0; Debt 4: $1795 – $72 minimum payment -$58 extra=$1689  

Month 21, $300 total payment  

    Debt 1: $0; Debt 2: $0; Debt 3: $0; Debt 4: $1689 – $68 minimum payment -$232 extra=$1412  

Month 22, $300 total payment  

    Debt 1: $0; Debt 2: $0; Debt 3: $0; Debt 4: $1412 – $56 minimum payment -$244 extra=$1131  

Month 23, $300 total payment  

    Debt 1: $0 Debt 2: $0 Debt 3: $0; Debt 4: $1131 – $45 minimum payment -$255 extra=$846  

Month 24, $300 total payment  

    Debt 1: $0; Debt 2: $0; Debt 3: $0; Debt 4: $846 – $34 minimum payment -$266 extra=$557  

Month 25, $300 total payment  

    Debt 1: $0; Debt 2: $0; Debt 3: $0; Debt 4: $557 – $22 minimum payment -$278 extra=$264  

Month 26, $300 total payment  

It’s taken less than six months to knock out the last remaining debt by devoting our entire monthly debt payment to it. By using the debt snowball method, we’re debt free in 2 years, with steady progress and motivating wins along the way.

    Debt 1: $0; Debt 2: $0; Debt 3: $0; Debt 4: $264 – $15 minimum payment -$249 extra=$0  

All the math shows the debt snowball method works. It gets your debts paid off faster, and just plain feels better because you see progress.

A person typing on a laptop that says,'repayment plan choose' prompting with on to choose.

But, is there another alternative? Yes, there is…

Debt Avalanche. Budget experts call it the debt avalanche, because instead of focusing on paying off the lowest balance first, you focus on paying off the debt with the highest interest rate first. In our examples above, we made all of the interest rates the same to simplify the math. But suppose one debt carried 12% interest and another carried a 21% interest rate. In that case, you would pay off that 21% rate first, even if it meant everything would take longer, because the higher rate is costing you more.

We’re not going to get into the math of the avalanche method, because it varies too much based on the rates you’re paying. But basically, you have 2 choices: put the extra money toward the account with the lowest balance, or toward the account with the highest interest rate. Before deciding which method to choose, remember that debt snowball yields quicker results which helps to maintain motivation, but debt avalanche results in paying less interest over time.

Some very important considerations  

Both of the methods above are useful strategies to get out of debt, but your overall success depends on some hugely important factors.

First, you have to stop borrowing. If you keep adding to your credit card balances, then all of your planning is thrown out of whack. If you’re picking a payoff strategy, whether it’s an avalanche or a snowball, you have to stop incurring more debt first.

Second, pay extra whenever you can. If you have extra funds in a given month–say you get a tax refund or cash gift–then putting that entire amount toward the debt you’ve chosen to focus on first means paying everything off that much faster and paying that much less in interest.

Just because you’re getting by month to month with your fixed debt payment doesn’t mean you shouldn’t throw extra money toward your debts if you have the chance.

Is there a 3rd way?  

These two primary debt repayment strategies aren’t revolutionary. Everywhere you look, or no matter what financial expert you ask, you’re going to hear about those two strategies. But a lot of people will suggest a 3rd option, which is debt consolidation. What they mean by this is taking out a new loan to pay off all of your credit card debts.  

It might be a personal loan, a special debt consolidation loan, getting a new credit card, and transferring balances, or accessing home equity through refinancing in order to pay off debts.

We do not consider this a viable debt reduction strategy.

Let’s double down on that because in fact this is not a debt reduction strategy at all.

Debt reduction means paying off debt month after month. Converting one kind of debt into another isn’t a payoff strategy, and it often backfires, leading to more debt in the end. We watched for decades as people refinanced their homes and put that money toward credit cards. Then the housing crisis in 2008 hit and homeowners finally realized what we’d been saying for decades: don’t trade good debt for bad. This means, don’t give up hard-earned home equity to eliminate credit card debt.

Attempting to consolidate debts ends up leaving you with paid-off credit cards you can keep using, while adding a new consolidated debt payment. It’s not long before most consumers have fallen back into bad borrowing habits, and when a second, much larger reckoning comes along, they no longer have an illusory debt consolidation lifeline to grab.

If you see financial experts suggesting debt consolidation as a debt reduction strategy, be wary, because they’re probably trying to sell you something. And that “something” is probably more debt.

More about consolidating payments  

You might wonder how a Debt Management Plan (DMP) differs from debt consolidation.

Sometimes you may see a DMP described as a form of consolidation. But it is important to understand that the debt isn’t consolidated. With a DMP, you make one consolidated payment. You’re letting someone else do all the complicated math and handle divvying up individual debt payments for you. But you’re not taking on more loans or credit to accomplish the payoff.

When we say we don’t think debt consolidation counts as a debt repayment strategy, we’re talking about any kind of debt consolidation loan, not the single monthly payment featured in a debt management plan. 

A few other options  

Today we’re talking about paying off debt, so all of these strategies depend on actually paying off debt over time. But there are a few other options that reduce or eliminate debt – those are debt settlement and bankruptcy.

A debt settlement means the holder of the debt forgives some portion of the debt, reducing what the borrower has to pay. Typically, the borrower will be expected to settle the debt with one lump sum payment.

For example, if you owe a creditor $20,000 and you can’t afford to repay the debt, you might approach them and offer to pay one lump sum payment of $5,000 to “settle the debt” entirely.

Why would a creditor accept so much less than what you owe? Typically, a settlement is negotiated with a debt buyer who isn’t the original creditor. Meaning you experienced a financial hardship and could not pay your debt; therefore, the original creditor gave up on collecting the $20,000 owed. They charged off the debt and sold it to a collection agency for a very low amount-pennies on the dollar.

If the debt collector paid the original creditor 5% of the amount owed to acquire your debt, and you pay them 25% to settle the debt, they still make enough profit to agree to your settlement offer.

The math might sound appealing as it saves you a lot of money, but settlements have a big negative impact on your credit, especially if the original creditor charged off the debt before they sold it.

Bankruptcy is a legal proceeding that wipes out your qualifying debt entirely. This isn’t something anyone should attempt without professional help. Counseling is required before filing, and you’ll want to file with the help of a bankruptcy attorney.

With bankruptcy, you legally declare yourself insolvent and unable to repay your debt. The bankruptcy court discharges your debt, and you no longer have to pay (in the case of a chapter 7 bankruptcy filing), or you pay back all or part of your debt in installments (in the case of a chapter 13 filing).

Looking at these different payoff methods, they’d vary based on how much you have to repay vs the impact to your credit.    

Payoff Method

Repaying debt; snowball or avalanche method
Debt Management Plan
Debt Settlement
Bankruptcy

 

Impact to Credit

Positive impact
Short-term impact (typically, 90 days)
Negative impact
Extremely negative impact

Amount Repaid      

Entire amount owed 
Reduced interest and fees; entire balance repaid within 5 years 
Debt settled for less than you owe
Debt greatly reduced or waived entirely     

Every person’s situation is different, so which method you use to repay your debt will depend on your unique debts and ability to pay. Generally, we think repaying debt through careful budgeting and planning is the best, or using a Debt Management Plan if you need extra help.

The other methods of satisfying your debt, like bankruptcy or debt settlement, are advisable in specific circumstances. Your best bet is to talk to a certified credit counselor to figure out which method would make the most sense for you.

If you’re like most people and you just need to figure out the best way to repay your debt without having to talk to a lawyer or debt negotiator, then we think the debt snowball is the place to start. This kind of strategy gets your debt paid off faster and feels better than other methods, because you’re achieving “wins” every time you pay off another debt.

Article written by
Melinda Opperman
Melinda Opperman is an exceptional educator who lives and breathes the creation and implementation of innovative ways to motivate and educate community members and students about financial literacy. Melinda joined credit.org in 2003 and has over two decades of experience in the industry.

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