December 21st may mark the official first day of winter, but tell that to mother nature. Southern Ontario has been blanketed with the white stuff early this year. In honour of the chilly temperatures outside and the holiday shopping season winding down, I thought it would be the perfect time to talk about the elephant in the room (or should I say polar bear) – holiday debt.
In a perfect world we’d all pay off our credit card balances in full and never pay a dime of interest. Unfortunately, life happens: your car breaks down, you lose your job or your roof starts to leak. An unexpected expense like this combined with a costly time of year like the holidays makes it tougher to avoid carrying a balance.
So, you have a balance on your credit card, now what? With credit card interest rates at 19 percent or higher, if you’re anything like me, you want to pay it off as quickly as possible. Let’s talk about two popular methods of reaching debt freedom sooner: debt avalanche and debt snowball.
Debt Avalanche
With the debt avalanche method, you start by paying down the debt with the highest interest rate. Let’s say you have two credit cards. Credit Card #1 is a standard credit card with an interest rate of 19 percent, while Credit Card #2 is a retail credit card with an interest rate of 29 percent.
Using the debt avalanche method, you’d start by paying off Credit Card #2 since it has the highest interest rate, while paying the minimum payment on Credit Card #1 (don’t forget this part, otherwise you could hurt your credit score by missing payments).
How much money do you put towards Credit Card #2? It depends. Create a budget (if you don’t already have one) and see how much you can reasonably afford to put towards your credit card balance. The FCAC has a handy calculator that shows you how much money you’d save in interest by paying off your credit card balance sooner. Hopefully this will motivate you.
Want to reach debt freedom sooner? Consider cutting back on your expenses or earn side hustle in your free time. For example, you could become an Uber driver or rent out a spare bedroom on Airbnb. The more money you bring in, the sooner you’ll be debt free.
Debt Snowball
The second popular method for paying off debt is debt snowball. Using the debt snowball method, instead of paying off the debt with highest interest rate first, you pay off the debt with the smallest balance first (think of it as rolling a giant snowball down a hill). Sometimes this is the same credit card and sometimes it’s not. It all depends.
Using the above example, let’s say Credit Card #1 has a balance of $2,000, but Credit Card #2 has a higher balance of $4,000. Using the debt snowball method, you’d start by focusing your cash flow on paying off Credit Card #1, while making the minimum payment of Credit Card #2.
I know what you’re probably thinking. This makes no sense. Credit Card #2 has the highest interest rate. While that may be true, for some people it’s more motivating to pay off to pay off one debt at a time. While you could pay off Credit Card #2 first, it will take you longer since the balance is double that of Credit Card #1.
The Bottom Line
There’s no right answer for everyone. It all comes down to personal preferences. Some people are motivated by paying down the most costly debt, while others are motivated by cutting up one credit card after another. Find the debt repayment method that works best for you, put your debt-free plan into action and rid yourself of your credit card debt sooner rather than later.