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"The Best Way To Get Out Of Debt"
This newsletter is about the issue of whether or not one should do a Debt Snowball, a Debt Avalanche or something else to pay off their debts. So... first, for those who don't know, let me explain what Debt Snowballing and Debt Avalanching really mean.
Debt Snowballing is when you pay off your debts from smallest balance to the largest balance. So if you had an extra $100 per month, rather than pay, for example, $20 extra on five different debts, you would put all $100 on the smallest debt and then once it is paid off, roll it over onto the next smallest debt, until you pay everything off and become debt free.
Doing a Debt Avalanche is very similar, except instead of putting the $100 on the smallest debt, you would put it on the debt with the highest interest rate, regardless of debt size, and once it is paid off, roll it over onto the second highest interest rate etc, etc.
While both of these methods work much better than haphazardly paying off your debts, the question is... which one works best?
Well.... let’s find out! Let's do an illustration.
Let us say that you are fresh out of college, so to join the Middle Class Matrix, you decide to go out and buy a new house and car to go with the debt that you have already accumulated. Now that you are in deep debt, it is time to make your game plan to get out of this debt and plan for retirement. Here are your current debts.
Mortgage = $165,000.
Interest rate = 7%.
Monthly Payment = $1,097.75
In this illustration we will say that you are able to scrounge up an extra $200 per month to work towards paying off your debt and going into retirement. This gives you a total of $2,145.96 to work with per month, and after you get done paying off your debt, you will then put your money into an investment vehicle that pays 9%. This illustration will start in September of 2009.
If you didn't do anything at all and just paid the minimum on all of these debts, which is what a lot of people do, it will take you 354 months to pay off the debt. So... your debt would be paid off in February of 2039. That is almost 30 years (if there is NO re-borrowing or charging, which is unlikely), and at that point most people start to think about planning for retirement. So we will use the 360 months (30 years) for this illustration.
The Following Website was used for the calculation illustration.
The following website was used for the investment illustration.
#1. Let us first check out the Debt Snowball method.
Using the Debt Snowball method, you will pay off the debts from smallest balance (CC #3) to largest balance (Mortgage) by first putting the extra $200 on the smallest debt and rolling it up to the top.
If you do it this way, you will be out of debt in 134 months, in October of 2020, with your last payment being $235.31. That will leave $1,910.65 in the 134th month. So let’s say you put that into an investment vehicle paying 9% for the remaining 226 months. If you invest the $2,145.96 for the remaining time, then after 30 years you will have $1,272,825.48.
WOW! That is a big difference. Buy using this method, you will be out of debt over 18 years sooner, AND you will be a millionaire at about the same time that you would have just been paying off your debt by paying the minimum payments! But does that make it the best method to use? Let us continue.
#2. Now let us check out the Debt Avalanche method.
Using the Debt Avalanche method, you will pay off the debts from smallest interest (Mortgage) to largest interest (CC #3), which is the smallest debt) by first putting the extra $200 on the highest interest and rolling it over to the debt with the lowest interest.
If you do it this way, you will be out of debt in 133 months, in September of 2020, with your last payment being $1,976.95. That will leave $169.01 in the 133rd month. So let’s say you put that into an investment vehicle paying 9% for the remaining 227 months. If you invest the $2,145.96 for the remaining time, then after 30 years you will have $1,275,020.64. That is one month earlier of being debt free, and approximately $2,000 in extra cash at the end, using the Debt Avalanche.
Now in this particular instance, the Debt Avalanche won, but not by much at all. Generally speaking, Debt Avalanche will always win. but it certainly won't be by a huge margin. Mathematically speaking, the quickest way to pay off your debt is from the highest interest to the lowest. But, if this is really the case, then why do so many people subscribe to Debt Snowballing? There are those that say that Debt Snowballing provides quick victories. If you pay your smallest debt off quickly, it will make you feel good and give you more motivation to move on. I can completely understand this, especially considering that there is not a big difference between doing the two.
With that being said, I am not one to do a financial plan based on how disciplined I think most people are. That is a slippery slope that many financial advisors choose to go down. That way they can (for example) sell someone a jacked up whole life insurance policy and justify it by saying, "Yes, there is a more economical way, but my client is not disciplined enough to follow through on it". In most cases, I just analyze and give the numbers.
#3. There is a method that has not been explored yet, and if you are reading this newsletter, you should feel lucky because you are one of the first to be exposed to this brand new revolutionary way to pay off your debt. It's called the "Let The Snow Melt" method.
Now let us check out the "Let The Snow Melt" method. In this method you will not pay down your debts from the smallest to the largest balance. You will also not pay down your debts from the largest to the smallest interest rate. In this particular method, you will not pay the debt off early at all! You will take the $200 and start your investment right away, and just pay the minimum on all your debts. Now, when each debt gets paid off, take that extra money and invest it rather than rolling it over to the next debt.
If you do this, at the end of 30 years your total will be $1,422,098.01. Now that is about $147,077.37 over the nearest competitor!
You see ladies and gentlemen, sometimes getting out of debt is just flat out overrated. That is why I don't believe in paying ones house off early. But this also applies to almost any situation. The “Pay Yourself First Principle” truly does work.
Now, do I normally recommend for people not to pay ANY debt off at all and just start investing? No... Not really. Why? Well... first, in a lot of cases Credit Cards will charge a minimum balance which is a percentage of the total debt, which means that paying the minimum will NEVER get you out of debt (or maybe in 100 years or so). But even with that you would have more money. And, of course, the second reason is that it would take EXTREME discipline to do such a thing.
So... I guess I just contradicted myself. Oh well.
The most important thing to remember is that it doesn't matter what method you choose IF YOU DON'T FOLLOW THROUGH ON IT! Sadly enough, most people don't have the discipline to do #1, #2 or #3 (while sitting there arguing about it). One can have an eight hour debate on what plan is the best, but the truth is that WE MUST ALL HAVE ONE, and we must be disciplined enough to follow through on it. I talked about these things in Financial Freedom Boulevard and Don't Do a Budget.
Now, while I would clearly choose #3 (Let The Snow Melt Method) to be my end result, options #1 and #2 are both good enough aren't they? Either way you would be better off than most. So make a plan that is customized for YOU and then DO it, because doing the plan is more important than the plan itself. Understand?
STILL TRUSTING IN THE U.S. DOLLAR?
While money continues to be printed up and "we the people" continue to go further and further in debt all in the name of "fixing" the economy, it is only logical that the U.S. Dollar is on its way out of the door.
Latest Bailout is over 8.5 Trillion.
And according to
some, government spending (which really means private
international banker spending) could surpass 23
Trillion! What?! Now that is over twice the current
Consider the following interview done by Peter Schiff a while back after the first bailout. He predicted what would happen if the "government" kept spending money. Well.... almost
Also consider that this new wealthcare... oops, I mean healthcare plan will also cost a lot of money. This money will all have to be printed out of thin air.
So at this point, you would be hard pressed to convince me that the U.S. Dollar isn't about to fall off greatly. So it will probably be a wise thing to learn how to invest in gold, silver and precious metals.
Gold and Silver Secrets
For more info on investing in precious metals, you can go to the FYMO Resources Center also.
So, until next time,
Free Your Mind... Online,
For more resources, go to the Free Your Mind Online Resource Center
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