Debt snowballs, avalanches, meltdowns …

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(well. free to readers …. come on over and see my new blog to see what all the fuss is about)!


Now for today’s post

There are three basic ways to deal with debt:

1. Sweep it under the carpet and hope it goes away … pretty much the middle-class American mantra

2. Peck and poke at it … barely keeping it under some sort of control

3. Systematically demolish it … the subject of this post

The methods for ‘demolishing’ debt basically all have to do with snow (Why? No idea!):

a) Snowballs – where you deal with the little guys first in order to ‘psych up’ with a few, quick wins

b) Avalanches – where you deal with the high interest debts first, so your debt repayment strategy builds up momentum

c) Meltdowns – where you try either of these methods (or some other way) and fail mid-stream

The Debt Avalanche, nicely described (and named!) here is mathematically the best way to deal with eliminating all debt. I also covered this method in a recent post.

As I said in that post, it stands to reason that if you tackle the high interest debts first, you lower your overall interest bill – hence debt. Therefore, you pay the lot off quicker …

… but, not much quicker as Dave Ramsey is quick to point out:

He says that the debt snowball isn’t terribly slower at paying off debt, but has a psychological advantage of allowing some quick ‘wins’ … by ordering your debts from smallest to largest and paying off the smaller ones first, you get to see the results that will hopefully sustain you as you start to tackle the larger debts (also, you are applying larger and larger amounts to each debt, as you have fewer and fewer ‘minimum payments’ to maintain as you go along … but, this is true with both methods).

Then you have the ‘Debt Meltdown’ aptly described by Diane, one of the Final 15 on my 7 Millionaires … In Training! ‘grand experiment’:

I’m in such a financial mess that I am working on 101 and not sure I’m going to survive that at times.  But I should.  I know I make a lot more money than many folks.  I shouldn’t be in this situation.  I could probably go back and show how it crept up because I was down to about 2k in debt, at 1.9% interest rate (sans the student loan), before I bought my house 2-1/2 years ago.  I’ve got 30k in debt now roughly and some months lately am not sure how I am going to meet all of the must-pay bills.

This is typically what happens when you start on any debt repayment schedule and something ‘comes up’ …

Diane should have stayed the course until all debts were paid off then bought her house, ensuring that her total mortgage wasn’t any more than the total monthly debt repayment schedule … if less, she should have applied the balance to her investment strategy (if she didn’t yet have an investment strategy, then she should have started that before considering the house).

All Diane can do now, is start a Controlled Meltdown …

… anyway, of all these methods, I actually like the Controlled Meltdown best  – and, for that to work you actually need to begin with the Debt Avalanche:

1. Order all of your debts from lowest interest rate to highest (regardless of size … if you have two debts at the same interest rate, tackle the smaller one first, just to please Mr Ramsey)

2. Decide how much each month you are going to apply to debt repayment (min. 10% – 15% of your net salary … after contributing to 401k … sorry no Starbucks, movies, or sushi for you!).

3. Pay the minimum on all of the debts except the one that you are tackling (always the highest interest rate loan that you have left). Put all of the rest of that month’s debt repayment into this ‘high interest debt’.

4. Repeat until …

[AJC: and, this is where a Millionaire … In Training! differs from the ordinary folk]

5. The interest rate on the remaining loans is lower than the return that you can get by investing your money elsewhere (buy some real-estate, leverage into some stocks, start a little business) … just remember not to accumulate any more debt and keep repaying the minimum on the ones that you do have.

6. Also, don’t forget to tie the investment time period to the loan: let’s say that you have a student loan at 2.9% that must be repaid in 2 years … make sure that you can sell (or refinance) your investment to pay it back: the student loan is acting as a proxy for your investment loan, so don’t get caught out.

This is the fastest method because you don’t need to pay off all of your debt right now!

The Controlled Meltdown (patents pending) recognizes that being 100% debt-free is not a useful financial goal; being 100% financially-free is … and, to achieve real financial freedom, you are going to need some well-directed debt to help you accelerate you Net Worth to the point that it indefinitely sustains you.

Your existing ultra-low interest rate loans are a great place to acquire that debt …

… because you already have them and just need to redirect that debt towards good rather than evil 😉