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What Is The Fastest Way To Pay Off Debt?
Scott A. T.: Broadcasting from One Dallas Tower, welcome to Be A Financial Rock Star Show. I’m your host, Scott Alan Turner, ready to help you get out of debt, save more money and retire early. In the studio with me, producer Katie, who has a new “Star Wars” T-shirt, thanks to some wonderful husband who bought it for her.
On the show today, I’ll be answering your questions about money business and life. If you have a question you’d like answered on the show, visit GoAskScott.com to leave me a voicemail.
In this show today, we’re going to do a deep dive on one topic, rather than break it up into parts over multiple episodes. It’s almost going to be like a mini course. I don’t know how long it’s going to be; it’s long as it is. It is what it is. It might take up the whole show, I don’t know. It’s a high-level topic on debt, but even if you’re debt-free, there is way more going on in the show than just the discussion of debt. It’s about choice, decision-making, behavior and, probably most important of all, questioning — asking questions. You’re going to get something out of it, no matter where you are on your financial journey.
We’re going to be questioning popular beliefs. We’re going to be questioning your own beliefs. It may not be what you want to hear, but it’s what you need to hear. When you ask better questions, you get better answers, which lead to better decisions and better outcomes and, ultimately, more money in your pocket. To ask better questions, you have to know what it is you’re questioning. I don’t even know if that made any sense. Let’s move on.
There’s a movie you can probably get for free … Yeah, it is free … if you’ve got Amazon or Netflix. It’s called “Super Size Me.” You may or may not have heard of it. When you’re thinking about your movie-watching queue, getting some free time, check it out. It is about a guy who lived on McDonald’s food for thirty days; that’s all he ate, every day, every meal. He wanted to track his health and see what happened. He checked into the doctor’s office, got a baseline set of health stats on day one; thirty days later, he went into the doctor’s office, got a different set of stats to see what happened in those thirty days if I lived off McDonald’s food. He gained a bunch of weight, he had higher cholesterol, his system was all messed up. He claimed he felt terrible after these thirty days of eating McDonald’s food.
The movie kind of put McDonald’s in a bad light, the food that they produce and the people that eat it every day, routinely, and how it affects their health. Another guy came out a couple years later and, if you watched that first video, you’re going to want to watch this second one. This video was called “Fat Head.” The guy in that movie, I’m going to read this here from the quote. It says, “He goes on an all-fast food diet” … No wait, do I have this backwards? No, this is right. “He goes on an all-fast food diet, mainly eating food from McDonald’s.” For his daily dietary intake, he keeps his calories to around 2,000, his carbohydrates to around 100 grams a day, but he does not restrict fat at all. He ends up eating 100 grams a day, of which about 50 grams are saturated, and he also decides that he is going to walk six nights a week, instead of his usual three.
After a month of eating McDonald’s on his diet, he loses 12 pounds. His total cholesterol goes down. No (this is from the description), his HDL goes down. Whatever, we’re not going to even get into that. That’s the good cholesterol, or maybe it’s bad. I don’t know. Anyway, cholesterol is not necessarily as good. What can you do with that information? Is McDonald’s good for you, or is McDonald’s bad for you? This guy went on a McDonald’s diet and he lost weight, which contradicts the other movie about how this person went on a McDonald’s diet and gained weight. Which McDonald’s diet is best? Which diet period is best? Is it a clean diet? Is it the Paleo diet? Is it the Atkins diet? Is it the South Beach diet?
You and I, we could argue in circles about the best diet if you wanted to lose weight. Dietitians do this. There’s a different diet of the month in every health magazine that comes out. If we just looked at the McDonald’s diet that I spoke of, you might think it’s not just about the food; it’s about the behavior. I can lose weight eating six donuts a day, speaking for myself, if that’s all I ate and I exercised. I may or may not be able to lose weight faster if I eat a 100-percent clean diet: all organic, fruit, veggies, whole grains, whatever. It depends on what? How much I’m eating, how many calories I’m taking in, what exercise I do, if any. It’s the behavior of what I am eating, not the source of the calories.
When it comes to paying off debt, there are several well-known strategies. There’s some lesser-known ones; I’m not even going to get into them because they’re too complex, and if ain’t simple, you’re not going to do it. For the sake of discussion today, we are talking about the most common sources of debts people have: credit cards, car loans, student loans, medical bills, personal loans. We’re not going to be talking about mortgages and business loans, but consumer debt, the debt that costs us money because of the interest rates we pay on it each month. Usually, that is wasted money: credit card interest or medical bill interest. The most popular and promoted get-out-of-debt plan that you’ll find nowadays on the Internet is called the Debt Snowball.
The math behind it is this: You get aggressive and you pay down the debts as quickly as possible at the cost of everything else in your life. That’s the first part of it. You don’t save for retirement. You don’t get your company match. You don’t eat out. You don’t go on vacation. You do nothing, nothing, absolutely nothing except pay off debt. Some people do this and it works for them, no question, no deviation on it. The way this program works is you take all your debts that you have — two, three, four, five, six, seven, however many you’ve got — you list them ordered in the smallest amount owed on the balance sheet to the largest. If you’ve got a $100 debt at Kohl’s or The Gap and you’ve got a $1,000 debt on Visa or MasterCard, you pay the Kohl’s card first, even if the Visa or MasterCard has a 0% interest and the Kohl’s card has got a 22% interest, Kohl’s comes first: smallest to largest on your debts. This plan works for a lot of people. It’s very successful.
What you don’t hear about are a lot of people, or a portion of people … I don’t have any numbers because there’s no data out there on this so I can’t give you a percent, but I’ve read about it in forums, Facebook groups, even from you when you write in to me. People don’t go in a straight line with this plan. They’ll do balance transfers to new credit cards, borrow money from Mom and Dad at a lower interest rate, keep doing the 401K contributions and getting the company match while they’re doing this or maybe even 15%, whatever. It just varies. People are given the guidelines and then they branch out as they see fit and what fits their specific situation.
There’s another debt-payback plan that’s called the Debt Avalanche. This plan works by listing out all your debts and you pay the ones with the highest interest rates first, ignore everything else. If you’ve got a credit card with a 22% interest and a car loan with a 10% interest, balances don’t matter; you pay the credit card first. Mathematically, and I’ll go over an example in a minute proving this, usually you pay less in interest, so it costs you less, when you do the Debt Avalanche method because you’re paying down the higher interest-rate debts first. Some people say “Well, if math were the problem, you wouldn’t have been in this situation to begin with.” Well, allow me to retort.
Math was what got me out of student-loan debt, looking at the interest I was paying. Lack of knowledge may put you in a place where you have big student loans, or have student loans period. Or the belief that it’s good debt … I still think student loans are good debt, but you have to be very clear on what is a reasonable amount of debt for those to take on. Different topic, different day. I would say lack of knowledge cause me to take on more debt in my earlier years than I should have. Not math, just not knowing.
There is also a debt-payoff plan called Debt Snowflakes. That’s us paying the minimums over the time for the longest possible period. It’s just paying your minimum balance on your debts. It’s not really a plan; it’s just staying broke. It would take you twenty to thirty years to pay off your debts that way. It is the most expensive way to pay off your debts and pay the most interest. It’s definitely not the fastest. We’re not going to talk about that.
Then there’s something … I’m just making up a name, I’m going to call it the Debt Snowplow. We get six inches of fresh snow, snowplow come out and plows out for us; i.e., we get a bonus, we get a tax refund, we get some extra cash, we don’t go out to eat as much this much, whatever. We throw a little extra at the debts, no rhyme or reason to it. It’s just, “Oh, I’ve got extra money in my pocket, let’s just pay down a little bit more.” It is what a lot of people do. They don’t have a plan; they just do what they can, when they can. This is what I did with my student loans when I got out of school, before I knew about any of this stuff, any of these debt-payback programs. I don’t even think these existed back then.
I look at my paycheck and I mentally calculate in my mind: “All right, I’ve got enough for rent in there in my checking account balance. I can make my car payment, my insurance, utilities. I’ll just mentally add this up. All right, it looks like I’ve got 100 extra bucks this month, or maybe I’ve got 200, 150, I don’t know. I’m just going to write that extra into the bill payment for the student loans this month and hopefully keep my checking account balance the same as it was before.”
A lot of people do this. It’s what I did. There are people that are extremely passionate about this topic. “So and so said this. This worked for me.” He or she is right, and there is just no other way. We’re not going to listen to anything else. It is what it is. No other plan is better or should even be considered. I can appreciate that stance. I have my views on which diets are better than others. I have my views on getting out of debt, based on what’s worked for me.
Today, I want to help you decide what’s best for you, or help you to explain what’s best for someone you might be helping get out of debt, or someone that you will help someday. You can articulate some points or thoughts or questions for yourself or others as you go through this journey. Before we hit the skip button and said, “Nope, this is not relevant to me. Turner, you’re completely wrong. It’s this way on the highway and that’s it. There’s just no other way.” Hear me out.
Why is the Debt Snowball method often call the most superior method to get out of debt faster, even though it can cost you more and might take you a little bit longer than, say, the Debt Avalanche? That’s an interesting question. It can cost you more because you’re not attacking your highest interest-rate debts first. At least on paper it can cost you more. It can also take you longer for the exact same reason. If you pay off your highest interest-rate debts first, you’ll have more money to apply to the lower ones. The quicker you pay off your higher interest ones, the faster you get them paid off. You could pay those debts off sooner if you’re on the Debt Avalanche method.
You may hear people who’ve tried this plan, the Avalanche plan, or they tried both plans and they find that the reason the Debt Snowball works, paying your smallest debts first, is because of momentum. It builds confidence. It keeps you going forward. It gives you quick wins. You’re modifying your behavior really quickly, and that’s why it gets you out of debt: changing spending behaviors. The quicker you can change the behavior, the quicker you can get out of debt. Would you agree or disagree with that statement? If that’s all I said to you: The quicker you can change your spending behaviors, the quicker you can get out of debt. I think we would all agree with that, setting aside any type of payment plan, any type of debts, whatever debts you have. The quicker you can change where your money is being directed, or not directed if you’re not directing at all, the quicker you can get out of debt.
The next point we’d have to agree on, or decide on, is what is the fastest way to get out of debt, if I’m picking one of those two plans. Here’s a quote from the book “Pound Foolish.” It’s by Helaine Olen. Anyway, it’s called “Pound Foolish” if you want to pick it up on Amazon. “Exposing the dark side of the personal finance industry.” It’s an interesting read. Here’s a quote from the book: “Journal of Marketing Research … They found a majority of people believe that the Debt Snowball was the best way to pay down their bills, so much they’ll even pay down the smallest debt first after being told of the financial error of their ways.” Then it goes on, “Two professors at Northwestern University published a paper in the summer of 2002 showing, at least as far as the debtors they studied, that building up willpower is more important than the actual numbers themselves.” The behavior, just what we talked about a second ago, not the plan. Start with the behavior.
Let me give you a scenario. Let’s say someone tries the Debt Avalanche method and they quit because it’s too hard. If your debts are a $30,000 car loan, a $4,000 credit card and a $480 Kohl’s bill, you try going in interest rate order, and the highest one is on the car, you’re going to attack that $30,000, which is the biggest debt you have. You might end up giving up because it’s a huge amount; it’s $30,000. You quit, you end up not doing it and failing. What do you end up accomplishing? Oh nothing. You’ve accomplished nothing. You tried the Debt Avalanche. It didn’t work because there weren’t any small wins or momentum at the beginning. This happens to some percentage of people. There’s no stats out there that I’m aware of, and then they fall into a relapse. Six, eight, twelve months later, still in debt, still in debt. Then they blame the plan: The Debt Avalanche didn’t work, when it was really the behavior because it’s hard to follow. It was a big goal a couple years out, knocking out that $30,000.
There are some people that try the Debt Avalanche and they switch over to the Debt Snowball. They get their quick win so they pay off the $480 Kohl’s in two weeks, and it’s like, “Oh, we’re working. We’re making progress. We’re getting momentum. Get that mindset going.” It doesn’t mean the Debt Avalanche doesn’t work. It just means it didn’t work for them. It’s not a math issue, no matter what plan you choose. If you’re trying to pay off debt or even if you’re trying to invest. If I invest and I get scared and I quit investing, that’s behavior. That is not math.
Math says, “Keep investing. Keep doing dollar-cost averaging. Keep trying to not time the market. Keep putting money in month after month, year after year, decade after decade.” If I choose not to do that, that’s my behavior because math tells me ten, twenty, thirty years out, stuff’s going to work. The stock market’s going to work. It’s going to function like it’s functioned in the past. It’s a spending discipline behavior issue. Personal finance? Eighty percent behavior, twenty percent head knowledge.
You got the knowledge right now. If you’re in debt, you’re not out of debt. It’s not because you don’t have the knowledge, it’s because you don’t have the behaviors or a plan, or a plan that you can follow or want to follow. You may have made some poor spending decision. You may have had some circumstances. I made poor spending decisions when I was younger. There you are. You’re in debt. That’s the situation you’ve got to work out of. If your goal is to get out of debt, pay off $30,000 in four or five years, it’s going to take a couple years, depending on your situation. It just depends. Maybe it’s going to take you a year or two. Maybe paying off student loans will take you a number of years; it took me two-and-a-half years. I certainly didn’t go cold turkey on everything during that time. Again, you go insane if you do that. Also, I didn’t have a lot of expenses at that time, and I didn’t have any of this knowledge. I just knew I didn’t like losing that money in interest.
From a dieting perspective, and even from a money diet perspective, trying to get those huge chunks first, using the Debt Avalanche method, it’s difficult to mentally wrap your head around it and stick with that behavior for a long period of time, no doubt about it. Many people, they find success with the Debt Snowball method, even though on paper, it can take a little longer and cost you a little more.
I want to give you a tool to help you in your decision-making process. This is all about knowledge and action so that you can work on your specific situation or maybe somebody else you know. Even though getting into debt is more often than not the result of a behavior over spending, getting out of debt is going to be the results of a new behavior: spending less, paying down the debt. How quickly you get to debt freedom, it may come from looking at the math and deciding on one path or the other. It is a math issue at some level.
There’s a calculator, I’m going to share … Well, it’s in the show notes, so it’ll be on there. It’s from a website called Vertex. It’s an eye opener. It could change the way you attack your debt. It’s free to use, up to five debts you can plug in and then you pay a small fee after that; it’s ten, twenty, thirty bucks, something. You can plug in your debts, minimum payments, interest rates, balances and compare side by side how long will it take to pay down your debts using the Debt Snowball versus the Debt Avalanche. You can see very clearly what one path is going to take you, how long it’s going to take, what interest you’re going to pay overall and the other path.
I want to use an example from Sharia. Back in Episode 74, I answered a question from her about tackling her debts. She gave me all her numbers. She wanted to pay down her debts. Medical payment: 0 percent interest, she had a $1,000 balance with a minimum $145 a month payment. Student loans for her husband: 2.3 percent, $11,000 balance, minimum $161 a month. Her student loan is a 5 percent, $5,000 balance and I’m just going to skip the rest of the minimums. Car loan: $17,000 at 9 percent and a credit card $12,000 balance at 9 percent as well. I gave her some suggestions what I would do to knock them out the fastest. Those were sell the car, re-fi the student loan, balance-transfer the credit card if she can get a 0 percent. Thankfully, I did not talk about using the Debt Snowball, or else I may be correcting myself right now, which I may end up doing anyways.
I plugged her numbers into the Vertex calculator and, making the minimum payments, just doing minimum payments, let’s see, using the Avalanche we paid $5,879 in interest, paid off in 46 months, using the Debt Snowball $6346, paid it off in 47 months. Five-hundred dollars more in interest using the Debt Snowball, and it only got us one month less. I’m sorry, it was one month extra than the Debt Avalanche but it cost us more to do it.
If you can recall, in the beginning I talked about Debt Snowball. The people who promoted this plan, they say, “No, you don’t pay the minimums. You attack. You stop your 401K contributions, you stop eating out. You don’t do anything but pay down the debt, which means you’re going to have more money to apply to the debt.” All right, let’s go that route. What if Sharia pays an extra $300 a month towards her debt? OK, Debt Avalanche: $4,357 in interest, 36 months. Debt Snowball: $5,293 in interest, 36 months. Identical timeframe, but it cost $900 less using the Debt Avalanche method. Same amount of time, three years.
OK, let’s keep going. What if I pay $600 a month extra on top of the minimums? Debt Avalanche: $3,475 in interest, 29 months. Debt Snowball: $4,457 in interest, 30 months. A thousand dollars in interest less using the Debt Avalanche, two-and-a-half years for each, one month difference, which is nothing.
All right, let’s go whole hog. Let’s say I’ve got a thousand dollars extra a month, I’m going to knock these debts out. Debt Avalanche: $2,746 in interest, 23 months. Debt Snowball: $3,650 in interest, 24 months. Nine-hundred dollars in interest less using the Debt Avalanche, same timeframe; well, they differ by one month, which is nothing. Every one of those cases, the Debt Avalanche comes out ahead, and the timeframes are nearly identical. They’re off by one month in each of those.
That was a real eye opener for me going through and plugging those numbers. That was just the first example I found. I was just going back through my old emails, like who gave me the numbers that I can plug in here? I got other examples, they may or may not have … I don’t know what the results would be. Sometimes one might work better, sometimes the other one. That’s why this calculator, it’s so powerful.
In front of you, you can print out the payment schedules for your specific situation. It’s an eating plan custom designed for you. It’s like having a free visit with a dietitian and they take your blood sugar and check that, your triglycerides, your cholesterol. They give you, “Here’s Plan A and here is Plan B.” Debt Snowball? Absolutely, it’s got the quick wins. There’s power there in behavioral change, using that plan. Debt Avalanche, well you can look at the spreadsheet … I like calendars, I like checking stuff off calendars. I found power in crossing off dates and putting dates on a calendar, not on the computer, something that you can stick up on the wall. I enjoy … When I was paying off my student loans, I wouldn’t say I enjoy, but I like looking at the debt balances go down each month on the statements. I found power in that. That was a behavior modification thingie for me.
Student loans, mortgages, credit cards, whatever you’ve got. I love the spreadsheet. You can print it out and as each of those thirty days go by, you can cross it off. It’s not ten years, it’s not five years, it’s not three years, it’s not a year. It’s however many thirty-day periods it takes. Thirty days, it’s quite tangible. It’s four weeks. You may have a lot of periods. You may have sixty of them. You may have sixty thirty-day periods, but I can grasp that a lot better than I can five years. I’m thinking five years to pay off a car loan. Five years, I don’t even have that many calendars. What am I going to put five calendars up on my wall and then at the very last one, December 31, I’m going to put an X? No. If I get a spreadsheet and they’ve got one through sixty and each one’s thirty days, every thirty days, I get to cross the line off, cross the line off, cross the line off. It’s going. to help me. It’s going to change my behavior. It’s going to give me something to look at.
Those are the differences between the two most popular debt-payoff plans. You can choose which one you want, you can find success in either one depending on your personality. You’ve just got to look at your past spending habits, what’s going to work for you, if you’ve got a significant other that’s part of the equation, you’ve got to do what’s going to work for them as well. Both of you have got to be on board. If you’re both on board with the Avalanche, if you’re doing that, there’s an app out there, Ready For Zero, you can check out that for your phone. That was built to give you those quick wins as you’re paying off those debts each month and using the Debt Avalanche. You get the text, “Oh, you made it another week” or “Pay down so much debt,” whatever, those little boosters as you go through this process. They give you the little quick wins.
The spreadsheet, it shows you the math and the savings behind the two main debt-reduction plans, whether there is any. I think that can influence your behavior as well, probably more than anything else because you can look at it and say, “Oooh, I’m going to save a lot more money if we go with this path” or maybe not. Maybe you decide you need those quick wins. What is best for your sibling, your neighbor, your coworker doesn’t mean it’s best for you. Paleo might work for them. The McDonald’s diet might work better for you.
I want to give you a couple other things to think about when you’re thinking about these different plans. Consumer debt versus student loans or car debt. Some things people don’t talk about is the debt-tax deductible. These calculators don’t factor that in. These plans don’t factor that in. Your student-loan interest may be deductible. Your mortgage interest, deductible. HELOC interest, deductible. Student loans can be deducted up to $2,500 a year, depending on the types of loans, your tax bracket, how much income you make. Because of that deduction, your student loan interest rate ends up being lower than the face value. That’s one thing to consider.
Is the debt bankruptable? Something else people don’t think about. Student loans are not. Credit cards are. Medical bills are. If you’ve got $40,000 in student loans at four percent and you’ve got a $15,000 car loan at four percent, which one should you pay off first? The $15,000 car loan is smaller. They have identical interest rates. Under the Debt Snowball, you’d pay the car loan off first because it’s a smaller balance, but the student loans, they are with you forever. You cannot get rid of them. They’re not bankruptable. A car loan is. Your situation or someone else’s might warrant considering that.
Can you exchange the debt at a lower interest rate? Roll it over to a balance transfer. If you get a 22 percent credit card, it costs you 3 percent to roll it over, you saved 18 percent interest. You’ve just got to watch when the grace period ends, something else to consider.
What else? Some people, they’re deciding … They picked a plan they liked. I’m going to take my $25,000 in credit card debt at 20 percent interest, I’m going to roll into a HELOC because that only charges me 4 percent, plus I get to deduct the interest on it for my taxes. You do that, you’re exchanging an unsecured debt for a secured debt, your home, and that works for some people. You can’t argue that it won’t save you interest money because it will: 4 percent is less than 20 percent. You balance that with the risk of what happens in an emergency, though, if you can’t pay your HELOC or your mortgage.
Let me get back to the original question. We’re wrapping this up. I guess we took the whole show, OK. What is the fastest way for you to pay off your debt? It’s look at all your options and pick the one that you’re most likely to follow and gives you the best chance of success. The most important decision is to make a plan and follow a plan. You can change the plan if you find it’s too restrictive or it’s not going fast enough. In fact, like a budget, you’re probably going to find you need to adjust the plan over time.
I would stick with the two simplest options, though: You either choose the Debt Snowball or you go with the Debt Avalanche. You make some short-term sacrifices so you can throw extra money at the consumer debts and get rid of them. It doesn’t mean you can never eat out for five years. Most people who get on these plans don’t live like that. There is some fluff in there for having a pizza or hot dog or whatever now and then to live a little.
They’re still working the plan, putting extra money towards the plan, but there’s no way if you go ask somebody who’s been working a plan for two-and-a-half years, go up to them and say, “You mean to tell me you haven’t gone out to eat once? You haven’t gone to a single wedding in the past two-and-a-half years? If you’ve got kids, you haven’t taken them out to McDonald’s or anywhere else in the past two-and-a-half years? You’ve cooked at your home 21 meals a week for two-and-a-half years? You’ve never bought a single Christmas present for two years? Birthday present, anything? No cake for your kids, anything like that?”
I’m telling you, you’ve got to have some fun in there; otherwise, you’re not going to follow the plan. Build it into the plan. Use the math to guide you which map you’re going to follow to the destination, rather than just picking up the number one-selling map and believing it’s the only road through the desert. You can have three people on the same highway. One might be in the HOV lane, one is in the fast lane, another is in the speed limit lane behind the 18-wheeler; the only difference is the speed.
Alright, that’s it for this episode. I knew it was going to be a long one. I’m host Scott Alan Turner. Rockstar Katie is my producer. The one link I mentioned in the show, the calculator, is available in the show notes at ScottAlanTurner.com. If you have a question you would like answered on the show, questions will be up next time. Visit GoAskScott.com, leave me a voicemail. Thanks for listening.
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