The Motley Fool Discussion Boards
Personal Finances / Credit Cards and Consumer Debt
|Subject: SpeleoFool's Rules - Debt Priority||Date: 11/4/1999 2:42 PM|
|Author: SpeleoFool||Number: 19189 of 310321|
Let's apply some of what we've learned. If you haven't been following my Rules messages, now is a good time to play catch-up. It all started with an Introduction (post#18962). Next, I wrote about the power of Interest Rates (post#18966). Then I discussed the importance of maximizing your Net Worth (post#19025). Now I want to show you how this knowledge can help you to Get Out Of Debt!
Most everyone here will agree that before you start to get out of debt, you need to address the habits that put you there. Before you do anything else you must resolve to stop adding new debt. Period. From this day forward, if you can't get it with cash you have in hand, you can't have it. Second, you must take inventory of your situation. Determine all of your debts and all sources of income. Third, you must organize this information into a budget. In other words, you need to build a plan of attack against your debts. That's where this post comes in.
If you're ready to plan your attack then read on. If not, I'd suggest browsing the Credit Card and LBYM boards for more advice about how to get started. There's plenty of golden advice and helpful Fools out there to assist you.
The Snowball Attack
One of the things you should have in your budget is a minimum amount that you pay each month to reduce your debt. Say this is $500. That means that you dole out that $500, sometimes more but never less, among your debts each and every month. Eventually this will get you out of debt. But you are Foolish. You don't just want to get out of debt; you want to fight that debt in the smartest possible way. The basic way to do this is through a "snowball" type plan.
The idea is simple. You apply the minimum payment to each of your debts, then take whatever is left over and throw all of it against a single debt. Let's call this your Most-Hated Debt (MHD). You are, in effect, paying down your MHD as fast as you possibly can. When that is paid off you will have all of your extra money from before plus the minimum payment from your MHD available to throw at a new debt. You then pick a new MHD and repeat the process.
So, how do you pick your MHD? I'll evaluate several common methods* below, then tell you the "right" answer. :)
* Disclaimer--I made up my own neat-sounding names for these methods
The Tiny-Balance Approach
Using this method, your MHD is whichever debt has the smallest balance. The advantage of the Tiny-Balance Approach is that it is the quickest way to free up minimum-payment money to apply to other debts. On the surface, this sounds like a very Foolish way to go, but it's not the fastest or cheapest way to get out of debt. However, that doesn't mean you should dismiss this approach. If, for example, you find that you