I've discovered (in the way Columbus "discovered" America--it's been around for a while!) a tool that has helped me immensely with my perspective on my finances. Over the years, we've accumulated a bit of debt, mostly student loans and some medical debt, that have us feeling just weighted down. It's hard to believe we'll ever be saving for a rainy day when every month our checking account is emptied just in time for the next paycheck. We don't spend frivolously, either. We cover our basics (household, medical, car, personal care, 401K) and put most of the rest towards debt, though we could stand to tighten the belt in a few areas. Our debt is a source of anxiety and discouragement for both of us. In fact, we can't even talk finances before bedtime because it gets my mind whirring and anxious!
There are a couple approaches to debt reduction that I've been reading up on and, appropriate to the season, they are based on snow.
The first method is the snowball strategy, where you pay off accounts in order of the size of the balance, beginning with the low balance accounts. Say you have five accounts, and can afford a $600 payment a month. You begin by paying $200 towards Account #1 and $100 towards the other four. When Account #1 is paid off, you now have $200 more to apply to Account #2, bringing that payment to $300. Your total monthly payment remains $600, but now you have less accounts to pay off. Your snowballing payment takes out your debt and gives a psychological boost every time you bring another account balance to zero.
The second method is the avalanche strategy. With this approach, accounts are prioritized not by balance alone but by interest rate first, and then by balance. This approach may take longer to bring accounts to a zero balance, but over the long run you pay less towards your debt because of the reduced amount of interest.
I'm not quite sure why anyone would choose the snowball as opposed to the avalanche strategy, but maybe for some that psychological boost is a needed part of debt relief? In any case, the strategy of applying a set amount of money each month towards debt until the debt is paid is one that is simple to include in a household budget. To make it more satisfying, using a debt reduction spreadsheet will show the projected progress and amount of time it will take to pay off. I think it's easier to follow a plan when you can see the progress you're making.
This is why I'm so giddy: I've put all our debts, including a hefty student loan portion, in the debt reduction worksheet offered by Vertex 42. (Find it at http://www.vertex42.com/Calculators/debt-reduction-calculator.html.) Most of our debts will be paid off in four years, and our student loans will be entirely paid off in six years. And all that money? In six years we can start really building our savings.
For this plan to work, we need to
- stick to a budget,
- have all payments set up on autopay, and
- periodically consult the worksheet when it's time for us to adjust our payments. The beauty of this approach is that we can schedule reminders for when that will happen because we already have it planned out!