What’s the Best Way to Pay Off Debt?

The Best Ways to Pay Off Debt

Debt consolidation, the debt snowball method and the debt avalanche method are some of the best ways to tackle debt, especially if you have high-interest credit card balances. Here's what you need to know about how each strategy works and when to consider it.

Debt Consolidation

How debt consolidation works: Debt consolidation involves combining several small debts into one larger debt, usually with a debt consolidation loan or a balance transfer credit card. This approach reduces the number of payments you have to make each month, ideally at a lower interest rate compared to your original balances.

In fact, many balance transfer credit cards offer introductory 0% annual percentage rate (APR) promotions to help you maximize your interest savings. Just keep in mind that balance transfer cards and even some debt consolidation loans come with upfront fees.

Who debt consolidation is best for: Consider this option if you have a good credit score—generally a FICO^® Score^Θ of 670 or above. You'll typically need good credit to get approved for a balance transfer card, and debt consolidation loan interest rates are most favorable for borrowers with good and excellent credit.

Debt consolidation can be particularly helpful for someone who has high-interest debt and is able to obtain a low interest rate that will reduce your interest charges.

Debt Snowball Strategy

How debt snowball works: With the debt snowball strategy, you'll start by paying the minimum amount due on each of your debts. If you have extra money you can put toward monthly debt payments, you'll add it to the minimum payment for your credit card or loan with the smallest balance.

Once you've paid off that debt, you'll take the amount you were putting toward it and add it to the minimum due on the loan or card with the next smallest balance. You'll repeat this process each time you eliminate a balance, creating a snowball effect with larger and larger payments until you've accomplished your goal.

Who debt snowball is best for: The debt snowball strategy is best for people who might find it difficult to stay motivated to pay off debt. Because this method relies on paying off the smallest debt and working up to the largest, you can see progress in a short period of time.

The snowball strategy may be especially beneficial for people with lower credit scores who can't qualify for a low-interest consolidation loan or a 0% APR balance transfer card.

Debt Avalanche Strategy

How debt avalanche works: The debt avalanche strategy works the same as the debt snowball approach but with one key difference: Instead of focusing on your smallest balances, you'll put extra payments toward your loans or credit cards with the highest interest rates.

Each time you pay down a balance, you'll roll your payments into the loan or card with the next highest interest rate until you're debt-free.

Who debt avalanche is best for: If you're uncomfortable carrying a lot of high-interest debt or you want to maximize your interest savings, the debt avalanche strategy might be ideal for you. That's particularly true if your credit score isn't high enough to qualify for a lower interest rate on a debt consolidation loan or balance transfer card.

Keep in mind, though, that you'll need to have the discipline to stick to your plan because you may not get the same early wins as the snowball approach, especially if your most expensive debt is also your largest balance.

How to Choose a Debt Repayment Strategy

Choosing a debt payoff strategy doesn't have to be a tough task. To help you decide on the best payoff plan for your needs, take the following steps:

1. Assess your situation. Start by making a list of your outstanding debts, including the balances, interest rates and minimum monthly payment amounts. It may help to review your credit report to make sure you don't miss anything.
2. Review your credit standing. Check your credit score to get a sense of your overall creditworthiness. This can help you determine whether debt consolidation is a viable option.
3. Create a budget. If you don't already have one, it's crucial to make a budget so you can more easily monitor your income and expenses and minimize new debt. This process will also help you calculate how much extra cash you can afford to put toward your debts each month. If you don't have much wiggle room, you can pinpoint some areas where you can cut back on spending and increase your debt payments.
4. Evaluate your options. Take time to carefully consider each of the three strategies outlined above to determine which one is best suited to your credit and financial situation and goals. If debt consolidation is in the running, get prequalified with some lenders to get an idea of what your terms might look like.
5. Choose a strategy and stick with it. After researching each option, choose the best fit for you and stick with it. Regardless of which strategy you use, it's important to track your progress and be aware of potential issues as they arise. In some cases, it may make sense to switch to a new approach if the current one isn't working. However, avoid the urge to give up or rack up more debt.

How to Manage Debt and Bills

Paying down debt can be challenging when you also have other important bills to pay. Here are some tips to help you find a balance.

Stick to a Budget

While there are several budgeting approaches to try, you may want to use one that provides more insight into your spending habits, such as a zero-based budget. With this method, you'll know exactly where each dollar you earn goes.

While it can take more time to set up and track, it'll make it easier to avoid forgetting about the bills you have to pay each month. It can also give you a chance to evaluate your spending habits and make adjustments to achieve your financial goals.

Learn more: How to Stick to a Budget

Create an Emergency Fund

As its name suggests, an emergency fund is a savings account designed to cover unexpected expenses as they arise. Examples may include car and house repairs, certain medical or vet bills or even basic costs following a job loss or income change.

While financial experts generally recommend keeping between three and six months' worth of expenses in your emergency fund, any amount is better than nothing. Look at your budget and determine how much you can set aside each month to minimize the need for more debt during financial hardship.

Learn more: Why You Need an Emergency Fund

Set Up a Sinking Fund

A sinking fund is designed to cover planned expenses that fall outside of your regular monthly budget. This may include insurance premiums paid every six months or once a year, annual memberships, family vacations, holiday spending or back-to-school expenses.

Incorporating these into your monthly budget can prevent surprises that have the potential to derail your efforts to eliminate your debt.

The Bottom Line

The ideal debt payoff strategy is the one that best fits your financial situation. Whatever strategy you settle on, it's important to monitor your credit regularly to understand the impact your efforts have on your credit score.

With Experian's free credit monitoring service, you'll get access to your FICO^® Score and Experian credit report. Additionally, you'll get real-time alerts when changes are made to your report, making it easier to stay on top of new developments and address potential issues before they cause significant damage to your credit standing.