I started reading money blogs a while back, after originally being linked from LifeHacker (I think). The first one that got my attention was Automating Your Money by Ramit Sethi on I Will Teach You to Be Rich. I have also started reading Get Rich Slowly. Somewhere along the line, although I can’t find the actual article, I learned about a method of paying off debt called Waterfall Debt Repayment.
The idea is this:
- Find out how much money you can afford to use to pay down debt
- Pay what you can on all of them (at least the minimum)
- Use whatever is left over from the max you can pay, after minimums are taken care of, and dump it all into one source of debt
- Pay off that first source of debt
- This is the key: Now that you have paid off one source of debt, DON’T roll that extra money back into your monthly budget. Instead, take all the extra money, plus that debt source’s minimum payment, and put ALL of it into paying off the next source of debt
- Repeat until all of your debt is paid off
Here is an example:
I have three sources of debt. A car loan ($5,000), student loans ($50,000), and credit cards ($20,000). The minimum payments are $250, $400, and $100, respectively. I have run the numbers, and can afford $1,200 per month to pay down debt. This is $450 more than the sum of the minimum payments ($250 + $400 + $100 = $750). I decide to pay off these debts in order from smallest to largest balance.
In one month, I pay the minimums on the student loans and the credit cards, which leaves me $700 ($1,200 – $400 – $100) to pay on my car loan. Assuming 0 interest, my balances are now $4,300, $49,600, and $19,900. After 6 more months, I only have $100 left to pay on my car loan. With $47,200 left on my student loans and $19,300 on my credit cards.
When the next month rolls around, I pay that remaining $100 (again – no interest in this example), and I have $600 left to add to my credit card payments, so I pay $700 (the normal $100, plus the extra $600) on my credit card that month. I now owe $0 on my car, $46,800 on my student loans, and $18,600 on my credit card. The next month, I have the full $800 to pay on my credit card (last month, I had to put $100 of that into the last of my car debt), and $400 on my student loans.
After 32 months, I have finally paid off my credit cards, in addition to my car. Only the student loans remain ($36,600), and every penny of the $1,200 per month goes to my student loans. On my 63rd month, I finally make the last payment on those.
That, frankly, is a lot of math. It doesn’t even account for interest or planned credit card usage (I pay off $500 per month, but put $300 back on). I wanted to know how long it would take me to pay off my actual debt, and if it would be faster to pay it off, depending on which ones I paid off first. That is why I created The Waterfall Debt Repayment Calculator (with the help of Adrian Hannah). Add all of your sources of debt, the amount you plan to pay on each, APR, usage, and total amount owed, plus the extra amount you can pay, then chose a priority order (Highest Total, Highest APR, etc), hit calculate, and it will do all the work for you.
Go ahead, give it a whirl. Let me know your thoughts in the comments. And feel free to report miscalculations/bugs, too.