LAST week’s column addressed the pros and cons of debt consolidation and the importance of being strategic in managing debts, especially multiple loans.

Today I want to focus on two major ways to reduce or pay off debts, including credit card debts. It’s important to reiterate that when it comes to personal finance, excessive debt is a hindrance to saving and investing. To achieve financial freedom or create wealth, debt has to be effectively managed. We should seek to be owners of assets and be mindful that debt can be a major deterrent to wealth creation and financial freedom. Wealth is created from owning assets. Personal financial management is critical to one’s well-being and everyone should aspire to be good managers of their financial affairs. It boils down to having or attaining good financial habits. You are never too old to develop good habits and shed bad ones — it requires discipline and patience. Some pre-retirees and retirees are forced to make changes to their financial habits because of looming debts which inhibit or delay their retirement plan.

The two most popular methods of paying off debts are known as the snowball and the avalanche. Being in debt can be overwhelming for some people, and just where to begin in digging their way out of debt can seem daunting and confusing, even hopeless. Let’s take a look at how the aforementioned methods can help in paying off debts.

The snowball method of debt repayment involves making minimum payments on all your debts, except the smallest one.

Firstly, all the debts are listed from the smallest to the largest. Special attention is given to the smallest debt and extra payment is made to it, thereby paying off the smallest debt at a faster rate. The aim is to put as much money as possible on the smallest debt so it is paid off quickly. When the smallest debt is paid off then the extra payment is made to the next smallest debt until it too is paid off, then clearing the next smallest debt by taking the same financial approach. When all the smaller debts are paid off then more funds will now be available to tackle the larger debts. The same pattern continues with clearing debts — from the smallest to the largest — until all debts are paid off. The snowball method is based on the concept that clearing small debts first will motivate the borrower to tackle the larger debts based on the momentum that is built up as each debt is cleared. This concept is akin to a snowball rolling downhill. It starts rather small but picks up momentum while getting bigger as it collects more snowflakes on its way down the hill. The snowball rolling down the hill describes the debts being cleared quickly, from the smallest to the largest.

The avalanche method of paying off debts places special attention on paying off the debt with the highest interest rate first, while maintaining minimum payments on the other debts.

Extra payments are made on the loan with the highest interest rate. It doesn’t matter whether the debt with the highest interest rate has the lowest balance outstanding since by paying off the high-interest debt early, the funds saved from the interest payment can be applied to the next high-interest debt. This approach continues with all the other debts until all debts are cleared.

In Jamaica, credit card interest rates are as high as 46 per cent per annum, and even higher in some instances. For credit card debts, the avalanche approach is likely to save more on interest payments than the snowball method. Both the avalanche and the snowball methods can positively impact the borrower’s credit card score when outstanding balances are reduced.

Which method should you choose in paying off debts? There is no best method as there are pros and cons to both options. The debt avalanche allows the borrower to pay less interest than the debt snowball method but it may take a longer time for the person to get out of debt because of the size of the balances owing. The debt avalanche is more suitable for the person who is disciplined and wants to get out of debt by the fastest and most cost-effective route. With the avalanche method, as debt decreases the interest fees decrease so the overall debt decreases at a faster rate. There are downsides to the avalanche method such as the length of time it takes to see significant progress. It can also become difficult for individuals to remain motivated.

The debt snowball provides a psychological boost that will motivate individuals to be committed to clearing debts quickly and becoming debt-free. Settling small debts first results in small wins that will ultimately lead to major wins. The debt snowball is also suitable for credit card debts. Every card debt cleared provides the impetus to clear the next as more funds become available. More debts are cleared quicker because the credit cards with smaller balances are paid off first. On the flip side, it takes a longer time to clear overall debts, and more interest is paid over time, in contrast to the avalanche method. Whichever method is chosen, getting out of debt is a gateway to financial freedom. Lest we forget, “The borrower is a slave to the lender.”

Grace G McLean is a financial advisor and retirement specialist at BPM Financial Limited. Contact her at: mclean@bpmfinancial
or visit the website: www.bpmfinancial.com . She is also a podcaster for Living Above Self. E-mail her at livingaboveself@gmail.com