Strategies to Pay Off Debt

Once you have everything organized, you can implement a debt payoff plan that is suited to your
specific situation. There are several different strategies for paying off debt. Each strategy has different
pros and cons, but all are heavily dependent on your own financial psychology related to debt and
spending.

The two primary methods for debt payoff are called Avalanche and Snowball. With Avalanche, you
pay off debts based on targeting the one with the highest interest rate first. With the Snowball
method, you pay off debts in order according to the balance owed.

The Debt Avalanche

With the Avalanche method, you pay off your debt accounts in order, starting with the one that has
the highest interest rate. Then you pay off the one with the next-highest interest rate, and so on until
all the accounts are paid.

The benefits of the Debt Avalanche are that you pay less total interest, and you get out of debt sooner
than with other strategies. Although it takes time to see progress, once you get momentum going,
your debts will begin sliding away…like an avalanche down a mountain slope.

This method is especially helpful for people who have a lot of high-interest debt, like credit card
balances. We recommend Avalanche as the most effective debt payoff method.

How to implement the Avalanche payoff strategy:

1. List debts in order by interest rate

2. Make the minimum payment on all accounts
3. Pay any extra toward the one with the highest interest rate
4. Continue until all debts are paid

The Debt Snowball:

The Debt Snowball method also has you pay off your debts in order, but in this case you start by
targeting the account that has the smallest balance, then the one with the next-smallest balance, and
so on.

The benefit of the Snowball is that you experience small successes early in the process, which may
help you stay motivated to stick with your plan. Every time you pay off a debt, you’ll have more
money to put toward the next one…like rolling a snowball and picking up more snow as you go along.
However, the Snowball method takes longer and you’ll end up paying more total interest.

This strategy is good for people who feel overwhelmed by the number of individual debt accounts
they have, and who need to feel a quick sense of accomplishment.

How to implement the Debt Snowball:

Step 1: List all your debts in rank order by balance owed, with the smallest balance first.
Step 2: Always make the minimum required monthly payment on every debt.
Step 3: If you have extra money left over from your budget, pay as much as you can toward the debt
with the smallest balance.
Step 4: When you’ve paid off the debt with the smallest balance, move on to paying extra toward the
one with the next-smallest balance.
Step 5: Continue in this vein until all your debts are paid off.

Other Methods of Debt Repayment

There are a few other strategies for repaying debt, but they carry much greater downsides and risk.
For most people, the (preferred) Avalanche method or the Snowball method, along with having a
solid, realistic budget in place and concerted efforts to improve their financial psychology, are the
best choice.

We present the following debt payoff tactics, then, with the strong caveat that you should consider
your personal situation very carefully before developing your plan. Each of these methods may have
benefits, but you must weigh those benefits against the potential risks and consequences. Remember,
there is no “quick fix” for a debt problem! Your unique situation and financial psychology should
determine which strategy(ies) you use.

Balance Transfers

If you have credit card debt, one option is to transfer the balance on your credit card(s) to another
card with a lower interest rate. Some cards that offer balance transfer opportunities even have a 0%
introductory interest rate for some period of time.

RISKS: The company may charge transfer fees for each balance you migrate to the new card. Be very
sure that any transfer fees are less than the interest savings you get. Also, note that this strategy only
works if you pay off your total balance before the 0% promotional period expires. Otherwise, all the
interest debt you would have incurred during the promotional period will be compounded onto the
principal. Schedule your full payoff payment a month prior to the end of the promotion, just to be
safe.

Personal Loans / Debt Consolidation

Some banks and financial companies offer personal loans that you might use to pay off credit cards
and other debts. If you have a lot of credit cards with different statement and due dates, a personal
loan may benefit you by streamlining your debts into a single monthly payment. This option only
benefits you if the interest rate on the personal loan is lower than the rates on the debts you use the
loan to pay off.

RISKS: First, the personal loan may have an origination fee. Check very carefully to ensure that the
origination fee is lower than the amount you’ll save in interest. Second, you are taking out another
loan to clear old debts – meaning you still have the same amount of debt. A personal loan is not free
money; you’re just shifting the debt from one place to another. Third, you must avoid using the
available credit on the cards you pay off, or you will actually increase your debt load! You should not
use this option unless you absolutely trust yourself to keep any bad habits in check.

Debt consolidation programs are similar to personal loans, combining multiple debts into a single
payment. That is, you make one monthly payment to the debt consolidation company, and they
forward the individual payments on to all your creditors for you. These programs typically are offered
by credit counseling companies or organizations.

RISKS: First, there’s no guarantee that your interest rates will be lower. Consolidating debt into a
smaller monthly payment just means you pay more in interest and stay in debt longer. That’s part of
the trap. Second, debt consolidation companies profit from your irresponsibility. They are businesses
– they’re selling a product. Many of these too-good-too-be-true offers exist solely to take advantage
of the fact that some people are not good at managing their money.

Remember that you cannot borrow your way out of debt. Loans and debt consolidation do not
eliminate your debt – they just move your exact same debt load to a different place.

Debt Settlements / Bankruptcy

In debt settlement, you negotiate with the creditor (such as a credit card company or collection
agency) to accept a smaller lump sum than the balance you owe to pay off the debt. If you’ve
encountered a hardship like losing your job or becoming disabled, such negotiation may be easier.
The benefit is that you get rid of your debt for a lesser amount than the balance you owed. The
downside is that all the accounts you settle will be closed, while their negative effect on your credit
remains.

RISKS: Although debt settlement can stop your late payments or collections from nicking your credit
score further, the damage is already done. Negative marks stay on your credit report for at least
seven years.

Bankruptcy is a last-resort option that legally erases your debts. However, the destruction bankruptcy
causes to your credit will be nuclear – and it will take seven years (or more) to recover. The legal
process can be lengthy and expensive, but talking with an attorney is 100%, absolutely essential
before you ever consider filing for bankruptcy.

Conclusion
Debt can be a serious threat to your financial security and peace of mind. But if you’re already in debt,
it’s not the end of the world. It’s simply a good time to get organized and create a payoff plan that
works for you. Although implementing your debt payoff strategy will be a key contributor to your
financial health, it’s also important to evaluate how and why you got into debt in the first place.
Addressing the root causes of any debt problems you’ve experienced can potentially improve your
a
chances of reaching your financial goals. Last but not least we recommend that you set up
financial plan that supports your financial goals and help you pay debt.
Canadians who have a financial plan reach their milestones and achieve
their ambition. Did you know that 35 % of Canadians don’t have a Financial
Plan?

How we can help?

If you don’t have a financial plan we can help you set up one for free.

We empower Canadians to manage debt wisely with a Financial Plan/ We

believe that everyone deserves an unbiased financial plan to be able to
achieve their goals. Since 2010 our Mission has been to promote financial
literacy among Canadians through the reinforcement of saving for a
purpose, self budgeting and conscious spending.

BOOK YOUR FREE ONLINE CONSULTATION

visit moneylesson.ca powered by the Financial Market

institute of Canada: Finmarket inc. Visit us at:
finmarketinstitute.org.

how to make money quickly?

Invest and reinvest your earnings wisely and early. This is called compounding.

Compounding interest is a powerful concept that can significantly improve your investment returns.
Compounding interest gives an investment the opportunity to increase exponentially, because your
money earns interest both on the principal and on the prior interest payments. Stated another way,
the interest you earn is calculated not only on the amount of money you invested, but also on the
accumulated interest your money generates over time. So you’re making money both on the money
you worked hard for, and also on the interest earned in your past returns.

Compounding interest requires two key ingredients: the reinvestment of your earnings, and time.

Understanding Compounding Interest

Time is one of most important factors that determine the benefits you receive. The younger you are
when you start getting compounding interest working in your favor, the bigger your advantage.
However, people of all ages can benefit from compounding interest. To illustrate how important time
is, consider this example: if someone 20 years old starts investing $200 per month and earns an
above-average return of 8%, that money has potential to turn into a million dollars by the time the
person reaches age 65. But if the same person waited until they were 30 to invest, and then put in
$200 per month, even at the same 8% return that person’s nest egg would reach only just over
$462,000.

Reinvestment of your earnings basically means not taking any money out of your investment account.
So you are reinvesting all earned interest, dividends, or capital gains back into your investments. By
doing so, you now generate returns from your past returns. For example, let’s say you invested
$1,000 and earned a high interest rate of 10%. The first year you would have made $100. By keeping
that $100 in the investment (e.g. not pulling it out at profit) you would be reinvesting those earnings
of $100. So now you would have $1,100 invested. Your return at the end of the second year would be
$110. At the end of the third year you would see a return of $121. Reinvesting creates a snowball
effect where your money multiplies at faster and faster rates.

Now, of course, by keeping your earnings invested, you are subjecting it to the same risk as your
original investment experiences. In our example, we are consistently earning 10% three years in a
row. This rate is not common, nor is any gain ever guaranteed. To achieve such a high return rate, you
would have to subject your investments to higher risk of loss.

Let’s use a short mental exercise to illustrate the power of compounding interest:

Would you rather have $100,000 now or 1 penny that doubles every day for 1 full month?

Due to compounding interest, doubling a penny every day will turn into $5,368,709.12 after 30 days!

Clearly, this example is not possible in an investment situation – it would mean getting a 100% ROI
every day! But it does show how even small beginnings can grow dramatically over time due to the
power of compounding interest.

a financial plan that supports your

Last but not least we recommend that you set up
financial goals and help you compound your investment returns efficiently
and early. We can help you build your financial plan.
visit moneylesson.ca powered by the Financial Market
institute of Canada: Finmarket inc. Visit us at:
finmarketinstitute.org.

How compounding debt interest destroy your financial goals?

If you owe money – on credit cards, taxes, or other loans – compounding interest is taking you
farther away from your financial goals. Every billing period, unpaid interest on your debts is added to
the principal amount you owe. Then, the following billing period, you will pay interest plus the unpaid
interest from the previous billing cycle.

Fixed-payment debts such as mortgages or vehicle loans, where the payment remains the same
across the full term of the loan, are calculated so that interest is paid every billing cycle. Some of your
payment goes toward paying interest, and the remainder goes toward paying down the principal
balance. However, making only the minimum payment on credit card debt is a prime example of how
you can end up paying interest on interest – month after month – without ever really putting a dent in
the principal amount you owe.

The negative effect of compounding interest is the reason why it is critical to pay down unsecured
high-interest debt before you start investing. If you pay 25% interest on credit card debt while earning
just 5% on your investments, you are at a net negative ROI of 20%. The money you invested would be
better spent paying down the high-interest debt. Your investments would have to earn greater than
25% ROI to justify investing the money rather than using it to pay down the high-interest debt.
Consider that 25% is a VERY high ROI, is extremely unlikely, and, in the event it did happen, probably
could not be sustained month after month. Bottom line: pay down high-interest debt before you
invest.

Calculating Compound Interest with a Calculator

Get your calculator handy, because you will be learning to calculate how compounding interest can
affect your finances. This simple activity will help you understand how compound interest works.

You invest $10,000 that earns a return of 5%* per year. At the end of one year, you will have made
$500:

$10,000 X .05 = $500

This figure is how much you earned.

If you reinvested these profits, you would just add your earnings to your original investment:

$10,000 + $500 = $10,500

Alternatively, if you intend to reinvest your earnings, you can simply add 1 to your expected return
rate like so:

$10,000 X 1.05 = $10,500.

This calculation combines the 2-step process shown above into a single step.

*Note: 5% is used for hypothetical purposes; your investment returns may make more or less than
that percentage.
The previous example shows how to calculate your return over a single period of time (1 year in our
example). But what about interest that compounds year after year?

Year 1: $10,000 X 1.05 = $10,500.00

Year 2: $10,500 X 1.05 = $11,025.00

Year 3: $11,025 X 1.05 = $11,576.25 … and so on.

This is a very simple, but tedious way of calculating compounding interest. Furthermore, it assumes
that interest compounds only once per year. More accurate calculations can be made using more data
and more math if you so choose. We’ll “up the math” here for additional education, but don’t worry if
it seems too complicated. The basic idea of compounding interest, as we showed previously, is the
key concept to understand.

To be clear: you do need to understand the following equation to successfully understand

investments, interest rates, or return on investments. This equation is more complex and provides
additional accuracy, but it will not make or break your future financial plans.

To calculate compounding interest in a single mathematical equation, you would use this formula:

Where:

A = future value of the investment (the dollar amount of your total investment: original principal plus
all interest earned)

P = principal investment amount (the original amount you invested)

r = annual interest rate (expressed in decimal form: 5% would be 0.05)

n = number of times interest is compounded in a year (“1” if compounded annually; “12” if

compounded monthly; etc.)

t = number of years of your investment

Example: You invest $10,000 that earns a return of 5% per year, compounded monthly (12 times a
year) and keep the investment active for 3 years:

Alternatively, you can just use an online compound interest calculator.

The Rule of 72
The Rule of 72 says that if you divide 72 by the non-decimal interest rate (that is, 10 rather than 0.1)
you receive on an investment, the answer tells you how many years it will take for that money to
double. The Rule of 72 helps illustrate that the earlier you start saving for retirement, the better the
chances that your money will double.

Examples:

If you have $10,000 in savings and are earning a 10% interest rate, your money will double in 7.2
years. 72 / 10 = 7.2

If you have $10,000 in savings and are earning a 5% interest rate, your money will double in 14.4
years.
72 / 10 = 7.2
If you have $10,000 in savings and are earning a 2% interest rate, your money will double in 36 years.
72 / 2 = 36

Conclusion
Understanding how compounding interest works represents another important step on the path
toward preparing to invest. Compound interest on investments works in your favor by giving your
investment an opportunity to increase at higher rates, because you earn interest both on the principal
you invested plus the interest you earned on the principal. Compound interest works against you
when you carry high-interest debt, like credit card balances. Once you understand how compounding
interest can benefit your financial plan, you are one step closer to getting ready to start investing your
money.Last but not least we recommend that you set up a financial plan that supports
your financial goals and help you pay debt.
Canadians who have a financial plan reach their milestones and achieve
their ambition. Did you know that 35 % of Canadians don’t have a Financial
Plan?

How we can help?

If you don’t have a financial plan we can help you set up one for free.

We empower Canadians to manage debt wisely with a Financial Plan/ We

believe that everyone deserves an unbiased financial plan to be able to
achieve their goals. Since 2010 our Mission has been to promote financial
literacy among Canadians through the reinforcement of saving for a
purpose, self budgeting and conscious spending.

BOOK YOUR FREE ONLINE CONSULTATION

visit moneylesson.ca powered by the Financial Market

institute of Canada: Finmarket inc. Visit us at:
finmarketinstitute.org.