Make a debt payoff plan.
Debt feels lighter once there's a plan. This lesson explains how interest works and the two most common ways to decide which debt to pay off first.
Why minimum payments aren't enough
Interest is the cost of borrowing. On a credit card, it's usually shown as an APR, a yearly rate. Each month, part of your payment covers that interest, and only the rest lowers what you owe.
When you pay only the minimum, most of it can go to interest, so the balance shrinks slowly. After interest and fees are covered, paying extra puts more toward the amount you owe and can reduce future interest.
Example: where a payment goes
A $1,000 card balance at 24% APR builds about $20 of interest a month.
- Pay $25: about $20 goes to interest, and only $5 lowers the balance.
- Pay $100: about $20 goes to interest, and $80 lowers the balance.
Same card, same month, but the bigger payment shrinks the balance 16 times faster. (Simplified: real interest depends on how your card calculates it.)
Two ways to choose what to pay first
Avalanche
Pay extra on the debt with the highest interest rate first. This usually saves the most money.
Snowball
Pay extra on the smallest balance first. You see debts disappear sooner, which helps many people stay motivated.
Either way, pay at least the minimum on every debt, and put any extra toward one at a time. When it's paid off, roll that payment into the next one. The best plan is the one you'll stick with.
Example: same debts, two orders
- Store card: $600 at 18%
- Visa: $2,400 at 24%
- Car loan: $8,000 at 6%
Avalanche starts with the Visa, because 24% is the highest rate. Snowball starts with the store card, because $600 is the smallest balance. Both finish with the car loan.
Quick check
You have $100 extra each month and use the avalanche method. In the example above, where does the extra go?
Your next move
List your debts in the Debt Freedom Planner. It compares avalanche and snowball with your real numbers and shows your debt-free date.
Finished this lesson?
Educational information, not financial advice. Examples are made up to show how the numbers work.