Sometime around the fifth grade, I literally wrote a paper about how Dave Ramsey should be the president of the good ole’ USA. Dave (we’re clearly on a first-name basis) was my first exposure to the world of personal finance. My parents would listen to his radio show in the car, where I would be forced to listen as well. Even a few years ago when I first started to get seriously concerned about my impending student loan debt, his book (Total Money Makeover) was the first one I gravitated toward, bought, and loved. I still love it.
I’m not currently following the “baby steps.” At least not in a strict sense. Dave Ramsey is totally opposed to debt and advocates getting out of debt as quickly as you can, no matter what. I can’t argue or say I’m opposed to that. He talks about using seven baby steps to become debt free and grow wealthy, and preaches the “debt snowball” method. This method involves listing all of your current debts (with the numbers – they can be pretty scary, especially if you haven’t been paying attention to how much credit card or student loan debt you’ve been accumulating), ordering them from lowest to highest balance, and aggressively paying the lowest balance off first while making minimum payments on all others. Once that lowest balance is paid, you move on to the next highest balance, adding the payment you were putting toward the first debt on top of your minimum payment for your next in order to pay it off faster. When you pay that debt off, you move onto your next, paying the minimum plus what you were paying toward both of the last two debts on top of that, and so on until you’re debt free. The point of this method is that by paying off smaller debts first, you feel a little victory and become more motivated to continue to pay off the rest of your debt. I think this is a GREAT method for some people, but it’s not the one I’m using.
I am following a version of the “avalanche method.” The idea behind this method is to aggressively prioritize the debt with the highest interest rate that will cost you more money over time, therefore saving money when all is said and done. You might not get that small-victory feeling as fast as you would with the debt snowball, but you’re saving money on interest that would have accumulated while you were paying off your smaller debts.
So, I’ve given you theory, but here’s what this looks like in actual practice for me and my family:
- My student loans totaling ~70,000 at 3.1-6.5% interest rates (all my loans are combined into one payment, but are actually a series of small federal subsidized and unsubsidized loans, with varying interest rates depending on the loan. Your federal student loans probably are too if you look closely. Why do student loans have to be so complicated?)
- Hubby’s student loans totaling ~30,000 at 3.1-6.5% interest (see above for explanation).
- Auto loan totaling ~12,500 at 1.89% interest.
If I were using the snowball method, I would pay off the car first (putting the minimum toward our student loans and putting any extra money we had toward the car), then put my car payment as extra toward hubby’s student loans until they are paid off, then put the car payment and hubs’ loan payment as extra money toward my student loans until they’re paid off. This sounds good in theory, and there isn’t necessarily anything wrong with it, but I know that in the long run, while I’m paying off my car loan and even hubby’s student loan, my higher balance student loan is accumulating a lot of interest that I will have to pay because I was only making the minimum payment and saved it for last.
Using the avalanche method, I know that my $70,000 loan at 3.1-6.5% is going to cost me a lot more interest if I save it for last than my $12,500 car at 1.89%. I’m really focusing on putting as much extra money as we can afford toward that student loan in order to pay the balance down. I’m using a modified debt avalanche because I know that a car is not an investment and I don’t like having auto debt because I wouldn’t want to be upside down on my loan if anything happened to the car. I’m paying about $150 extra toward the car per month to help pay it off faster, but my main focus is still putting all extra money after that toward my student loan.
When a mortgage is added to this mix in a month or so, it will be our last priority because we plan to live in the house for a while and want to pay off all other debts before that one. I definitely want to be debt free, including the mortgage, and we’re slowly (it feels that way, anyway) but steadily making progress.