By Andrew Housser
It takes dedication and commitment to get out of debt. It also requires a plan. If you can only afford to make minimum payments on your credit cards and other loans, then keep at it. But if you have any cash -- even a small amount -- after paying all necessary monthly expenses, it is a wise idea to apply it toward paying down debt.
Several schools of thought exist on the best way to pay off debt. Two of the most popular methods are nicknamed the "snowball" and the "avalanche" methods. To determine which path is best for you, check out these pros and cons.
The Snowball Method
Think about how one makes a snowball: start with a small amount of snow and then add more to it. The snowball method of debt payment takes a similar approach: start small and end big.
First, make a list of outstanding debts, including credit cards and student loans, and the minimum monthly payment owed for each. Rank these in order from smallest to largest debt. Next, pay the monthly minimum balance on all debts except for the smallest one. Each month, apply as much extra money to the smallest debt as possible.
Once the smallest balance is eliminated, use the same approach to tackle the next smallest balance. Continue this way until everything is paid off.
The Avalanche Method
Avalanches start at the top and work their way to the bottom. The avalanche method of debt repayment focuses on how much interest each creditor is charging. First, make a list of outstanding debt including credit cards and student loans, and the interest rate charged for each. (Find your interest rate on your monthly statement, your online account information or by calling the creditor to ask.)
Rank the debts in order from the highest to lowest interest rate, regardless of total amount owed. Then pay the monthly minimum balance on all debts while applying as much extra money as possible to the debt with the highest interest rate. Once that balance is eliminated, move on to the balance with the next highest interest rate. Continue until all balances are gone.
Which method is right for you?
There is no right or wrong choice. What is important is that you are making at least the minimum payments required and taking action to knock out all debt.
In the long run, the avalanche method will get you out of debt quicker while saving more money. That is because high interest rates compound quickly and can keep you in debt for a very long time.
Paying more on the highest interest debt reduces the amount spent on interest charges every month. This frees up cash to chip away at the rest of your debt. Federal government sources recommend the avalanche method because it makes the most economic sense.
On the other hand, a 2012 study published in the Journal of Marketing Research found that more people actually succeed in eliminating debt when they use the snowball method.
Findings suggest that the quick win of paying off a debt -- no matter how small -- motivates people to stick to their plans and keep chipping away at the rest of their debt. While the method costs more in the long term (due to compounded interest), it increases the probability of reaching the ultimate goal, which is paying down all debts.
This research suggests that the concept of getting out of debt is as much a psychological battle as it is a financial one.
Regardless of which approach you take, keep in mind several things. The goal is to get out of debt, and then to stay debt-free. Cut up or store your credit cards if necessary to maintain discipline. Do not get lured in by special offers or discounts that tempt you to open new accounts. Establish a budget and stick to it. Learn to live within your means, buying only what you can afford using cash or debit, and save for bigger purchases. Finally, savor your debt-free status. You will have earned it.
Andrew Housser is a co-founder and CEO of Bills.com, a free one-stop online portal where consumers can educate themselves about personal finance issues and compare financial products and services. He also is co-CEO of Freedom Financial Network, LLC providing comprehensive consumer credit advocacy and debt relief services. Housser holds a Master of Business Administration degree from Stanford University and Bachelor of Arts degree from Dartmouth College.