Using the debt snowball strategy
First, be sure that you’ve budgeted enough to cover the minimum monthly payment for every debt. Now, arrange the debts by balance, from smallest to largest. Disregard the interest rate on each.
Every month, put the extra money you budgeted for getting rid of debt toward your smallest debt — even if you are paying more interest on a different one. Once the smallest debt is repaid, take the entire amount you were paying toward it (monthly minimum plus your extra money) and target the next-smallest debt. Keep knocking off debts and then diverting all the freed-up money toward the next debt in line.
Here’s how it could look in real life: If you have a hospital bill for $1,200 that the hospital is allowing you to pay interest-free, and two credit card bills for $5,000 (at 22.9% interest) and $3,000 (at 15.9%), you’d pay the hospital bill first. That’s right — you’d pay the interest-free loan before you paid those that accrue interest.
This can make numbers people crazy because it usually saves time and money to pay the highest-interest debts first. The debt avalanche method is a better fit for them. But if you need to front-load your payoff plan with early victories in order to stick with it, snowball is for you.
If you choose the snowball strategy and your high-interest debts are also the largest, don’t ignore opportunities to find lower rates, especially if your credit score is climbing. You may be able to transfer a credit card balance to a lower-rate card or find a debt consolidation loan.
Using the debt avalanche strategy
Proponents of the debt avalanche approach include NerdWallet columnist Liz Weston. “You’ll get out of debt more quickly by going after toxic debt first,” she says. “On the other hand, if you truly don’t think you’ll succeed without making small victories, a debt snowball is way better than doing nothing at all.”
Oftentimes, people can address their debt by creating a budget and sticking to it, which frees up cash to implement an avalanche debt-payoff strategy. Once you’ve got a handle on what you owe and where you spend, it’s time to start on the avalanche.
Add up all the minimums you must pay on your debt — ordered from the highest interest rates to lowest — and then figure out how much extra you can pay beyond the total of your minimums.
Let’s say you have a hospital bill for $300, and the hospital is allowing you to pay on it interest-free. You also have a credit card balance of $2,500 at 22.9% interest and another of $5,000 at 15.9%.
That $2,500 credit card balance becomes your top priority because it carries the highest interest rate. If you can put an extra $200 over your total minimums to pay off debt, it will go to that one until it is paid off. Then you add that debt’s minimum to the $200 extra and put the total toward the bill with the second-highest interest rate.
Continue knocking off debts and rolling their minimums into the extra debt payment amount until all debts are repaid. If a promotional interest rate ends, you may have to reorder your debts to keep your focus on the one with the highest rate.
Both an avalanche and a snowball use money you’ve committed to pay off debt. Sometimes, though, you happen across “extra” money, like a rebate check or a full jar of change. You can supplement either payoff strategy by using that found money to further chip away at debts (the “snowflake” method).
How does debt consolidation work?
There are two primary ways to consolidate debt, both of which concentrate your debt payments into one monthly bill:
Get a 0% interest, balance-transfer credit card: Transfer all your debts onto this card and pay the balance in full during the promotional period.
Get a fixed-rate debt consolidation loan: Use the money from the loan to pay off your debt, then pay back the loan in installments over a set term.
Two additional ways to consolidate debt are taking out a home equity loan or 401(k) loan. However, these two options involve risk — to your home or your retirement. In any case, the best option for you depends on your credit score and profile, as well as your debt-to-income ratio.
When debt consolidation is a good idea
Success with a consolidation strategy requires the following:
Your total debt excluding mortgage doesn’t exceed 40% of your gross income
Your credit is good enough to qualify for a 0% credit card or low-interest debt consolidation loan
Your cash flow consistently covers payments toward your debt
You have a plan to prevent running up debt again
Here’s a scenario when consolidation makes sense: Say you have four credit cards with interest rates ranging from 18.99% to 24.99%. You always make your payments on time, so your credit is good. You might qualify for an unsecured debt consolidation loan at 7% — a significantly lower interest rate.
When debt consolidation is a bad idea
Consolidation isn’t a silver bullet for debt problems. It doesn’t address excessive spending habits that create debt in the first place. It’s also not the solution if you’re overwhelmed by debt and have no hope of paying it off even with reduced payments.
If your debt load is small — you can pay it off within six months to a year at your current pace — and you’d save only a negligible amount by consolidating, don’t bother.
Try a do-it-yourself debt payoff method instead, such as the debt snowball or debt avalanche.
If the total of your debts is more than half your income, and the calculator above reveals that debt consolidation is not your best option, you’re better off seeking debt relief than treading water.
How a debt management plan works
Where to go: Debt management plans are offered by credit counseling agencies. If you’re thinking of going this route, look for an agency that’s a nonprofit and accredited by the National Foundation for Credit Counseling.
Expect a credit counselor to go over your financial situation thoroughly and to discuss several options, not just a debt management plan. Don’t feel pressured to sign up the same day any program is offered. Take time to think about it.
What’s covered: Unsecured debts, such as credit cards and personal loans. Secured debts — such as those for houses and cars — aren’t covered. Nor are student loans.
What the agency does: The counselor will contact each creditor to notify it of the debt management plan and make itself the payer on your account. The counselor may seek concessions from each creditor, which can include lower interest rates, lower monthly payments or “re-aging” an account to stop late fees.
Each month, your payment will go electronically to the counseling agency, which then pays your creditors. You get a progress report each month.
You’ll likely pay an enrollment fee as well as a monthly fee for each credit account in the plan. (Even with those, your overall monthly payment should be lower.) The fees can vary depending on state regulations, but agencies charge $20 to $30 on average.
What to expect while on the plan: Be prepared to live without credit cards for as long as you’re in the program. Most credit card issuers will require that an account entering a debt management plan be closed. You may be allowed to keep a card for emergencies or business, though; ask before you sign up.
Also, avoid any new credit obligations for the duration of the plan. Your creditors will see any new obligations on your credit report, and they may withdraw their concessions.
You should strive to make the payments on time, every time. Creditors have given you some major concessions, and they tend to insist on you meeting their terms. One missed payment and they may be done with waiving fees and charging less interest.
When debt management plans work best
If you’re struggling with revolving debt, the upsides are:
A single, lower payment.
No more (or at least fewer) phone calls from creditors or collectors.
The ability to finally put debt behind you.
It’s probably not right for you if:
You are having trouble paying secured debts, such as a mortgage or car payment.
Your income barely covers necessities, such as food and utilities.
You want to continue to use your credit cards.
Having to live without credit cards or new credit might be an advantage if you worry about controlling spending.
Because you have to commit to many months of payments, you’ll want to make sure there is room in your budget to do so. Over the years you’re paying the plan, unexpected expenses will crop up, so access to some kind of emergency fund is crucial.
It’s even possible that financial coaching, by itself, is all you need to catch up. If you decide a debt management plan is right for you, it’s smart to get help with budgeting and money management to prevent you from falling behind again.
Is debt management the right option for you?
A debt management plan is only one option when debt seems overwhelming, and it might not be the right one for you.
Your credit score might initially drop, as accounts are closed and you have less available credit. Enrollment in a debt management plan will be noted on your credit report, but it is supposed to be treated as neutral in credit scoring. Long term, as you get a handle on your finances, your credit score is likely to climb.
Data is sparse, but what is available suggests at least half of clients don’t successfully complete the plans. We suggest asking if your counseling agency will share its completion rate data with you.
Alternatives to a debt management plan include:
Debt consolidation loans, although terms and qualifying depend on your credit score.
Bankruptcy, which can be the best option when your debt is overwhelming.
Debt settlement, although there are significant downsides that make it a last resort.
You may be able to do for yourself some of what credit counselors would do for you in a debt management plan. For example, you could pick up the phone and ask your credit card company about hardship programs; the worst they could do is say no.