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How to Pay Off Debt: Determining Your Best Course of Action

Personal finance gurus love to argue about which debt you should pay off first. Browse the Internet for just a few minutes, and you'll find volumes of painfully long articles rehashing the same old approaches to paying down debt.

If you haven't found the time to read them all yet, there's no need to worry. Here's a summary of what they basically all say in one sentence.

Either pay off the smallest debt one account at at time, or get rid of the highest-interest debt first. Neither of these methods are new. Rather, they've just been given fancy new names.

Dave Ramsey's "Debt Snowball" Method (pay off small debts first) has garnered a significant amount of recognition due to the popularity of his book entitle "The Total Money Makeover." And the "Debt Avalanche" approach, eloquently blogged about by Flexo at Consumerism Commentary, is simply another way of saying mathematical rules shouldn't be ignored - paying off high-interest debt first is unarguably the economically smart path to take in any situation.

The truth is, like most things in personal finance, no single method will work for everyone. So, if you're more interested in finding out what will work for you instead of spending hours reading detailed analyses of why one method trumps the other, simply try asking yourself the following three questions before determining what course of action to take:

1.) Do You Have an Emergency Fund?

If not, stop right here! You need some kind of an emergency fund in place before you should even contemplate how you will pay off your existing debt.

In a perfect world you would have at least six months' worth of expenses stashed in a high-yield online savings account. However, if that seems financially impossible for you at the moment, take Dave Ramsey's advice and save at least $1,000 cash before moving to question number two.

2.) What's Your Motivation?

Do you need to experience small wins to stay motivated? If so, start your journey by paying off the smallest accounts first. Relish in the joy of watching your balances hit the big zero, and get yourself as pumped up as possible about each little victory. You'll need it to make it through the long haul because this route probably won't be the fastest way to get rid of your debt.

On the other hand, if saving money alone gets you motivated enough to stick to your plan, the Debt Avalanche is the way to go. You can still enjoy small wins along the way by performing periodic calculations to determine how much you've saved each month in interest. When you hit the $1,000 mark, reward yourself with something nice (and cheap).

3.) Why Not Mix the Two Methods?

For many individuals, the best method for paying off debt is often a mix of the two approaches discussed above. For couples, this is almost always the case. Compromises have to be made to keep both spouses engaged and motivated throughout the process.

So, if you have some small debts that have lingered for years, get rid of them first to build some momentum. Then you can tackle the larger debts according to their interest rates and terms.

Regardless of what course of action you decide to take, the important thing is sticking to your plan and watching the debt disappear. It will take time, self-control, and perseverance, but the reward is well worth the effort.

Now, go and make it happen!

on Thu, 2011-01-20 16:00