What is the best way to pay off debt?

The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.

CNBC reported in November 2021 that the average American has around $90,000 in debt. How each person’s debt is distributed may vary, as you could be paying off credit cards, a car loan, your mortgage and personal loans at the same time. While you can eliminate debt over time by simply paying your bills and not borrowing any more money, you could save thousands of dollars on interest payments by taking a more strategic approach and finding the best way to pay off debt for you. 

This guide reviews a few of the best ways to pay off your debt. Before you decide on the perfect strategy, however, you need to take stock of your current situation and financial capabilities.  

First, review your budget

You should review your monthly income and bills to determine how much of your money is going to pay for what you need, whether you’re spending too much on things you could live without and if you’re saving enough money. Many debt management advisors recommend using the 50/30/20 rule as a guide for your monthly spending.  

• Commit 50 percent of your income to the things you need, such as shelter, food, transportation and utilities.
• Allow yourself to spend 30 percent on things you want to have, such as entertainment, vacations, technology and recreational activities.
• Save 20 percent of your money so you can build up an emergency fund.

It can be difficult to follow the 50/30/20 rule if your debt is forcing you to commit most of your money to bills. This is why eliminating your debt is one of the most important steps you can take toward achieving financial independence.  

Once you’ve assessed your budget, you can determine how much additional money you can dedicate to paying off debt faster.

Option 1: The debt avalanche approach

If you have balances on multiple credit cards, a car loan and a personal loan, you could use the avalanche approach to save on interest payments, which can be quite expensive in the long run. Using this method, you make all of your minimum payments, and then you put any “extra” money toward paying off the highest-interest debt first.

Once you’ve done that, you work to pay off the debt with the next-highest interest rate, and so on, until you’ve completely eliminated your debts. Here’s an example of how the debt avalanche method works: 

• You’ve financed a car at an 8 percent interest rate and have $8,000 left on the loan. Your payment each month is $250.
• You took out a personal loan at a 13 percent interest rate, have $1,500 left to pay and need to pay $100 a month.
• You have a balance of $1,000 on a credit card with an interest rate of 29 percent and the minimum payment is only $50 per month.
• You have a second credit card with a $500 balance and a minimum payment of $35 per month, but the interest rate is only 19 percent.

If you were to pay all your minimum payments and nothing more, you’d be responsible for $435 each month. If you can commit an extra $200 per month to getting out of debt faster, you’d continue to pay all your minimum payments except on your high-interest credit card. That means you’d pay $250 per month on that credit card while meeting your other obligations. 

Once you pay the first credit card off, you’ll be able to put that $250 per month into paying off your other debts. This means you could pay $285 each month on the second credit card until it’s paid off. The personal loan would be next, and at this point, you’d be able to pay $385 per month on it. By the time you reach your car loan, you’ll be able to pay $635 per month on that balance, which is more than double your original payment.  

The debt avalanche method is the most effective way to pay off your debt if you’re most interested in saving money on your interest payments.  

Option 2: The debt snowball method

The debt snowball method is similar to the avalanche approach, but it allows you to feel a sense of accomplishment sooner. Instead of paying your bills in the order of the highest interest rate, you’d pay off the lowest balance first—after making all of your minimum payments, of course—and then work your way to the largest balance, ignoring interest rates entirely. Using the example above, your payment order would be as follows: 

• The second credit card, with a balance of $500
• The first credit card, with a balance of $1,000
• The personal loan, with a balance of $1,500
• The auto loan, with a balance of $8,000

The snowball method can help if you’re the type of person who needs extra motivation or to see success quickly. It’s not the most effective method when accounting for total cost because you could pay more interest with this method than if you use the avalanche method, but it does have its benefits.  

Option 3: The equality method

The equality method for debt repayment is to divide the amount of money you can commit to paying off your debt equally among all your bills. In the above example, if you’ve committed $635 per month to paying your bills, you’d split it four ways and pay $158.75 a month on each debt. You may notice immediately that the minimum car payment is $250, so you wouldn’t be able to use this method unless you’d budgeted $1,000 per month. 

For this reason, the equality method is only feasible if you have enough money to pay all your bills equally while still making the minimum payments. The advantage to the equality method is that it’s simple and easy. You simply pay the same amount each month for each of your bills and don’t need to worry about any extra math.  

Other options for eliminating debt

There are other options you can consider if you’re having trouble paying your bills each month that may reduce your monthly payments and even allow you to pay your balances down faster. While bankruptcy is a last resort that leaves a lasting impression on your credit, there are two alternatives that could work.  

Consolidating debt

Debt consolidation rolls all your existing balances into one. You apply for a single loan in the amount of your total debt so that you make a single payment each month. In many cases, you may be able to save money on interest payments if the rate you receive on the debt consolidation loan is lower than what you’re currently paying.  

Refinancing debt

Another alternative is to refinance one or more of your loans. For example, you could lower your monthly payments if you were approved to refinance your auto or home loan and save a significant amount of money that you could put toward paying off other debt faster.  

Which method is best for you?

The best way to pay off debt depends on how much money a person is able to commit to paying down their debts and their personal preferences. If you want to just have a set payment amount for all your bills, you may wish to use the equality method. If you’re concerned about saving money in the long run, the avalanche method may be ideal. And if you want to gain momentum to stay motivated, you may want to consider the snowball method.

If you choose to seek a debt consolidation loan or refinance one of your loans to lower your payments, it’s important to make sure your credit isn’t being weighed down by errors on your credit reports so you can receive the best interest rate possible. Lexington Law could help you work toward repairing your credit and consider ways to maintain your financial health. Contact us today to learn more.  

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