What’s the best way to pay down debt?

Q. I am retired and have money coming in every month from my company pension and Canada Pension Plan (CPP) totalling about $3,400 net per month. I bought my parents’ home and paid for it in full, in cash. But it needed a lot of work and I went into debt in order to cover the maintenance and renovations. I now have total debt of about $82,430. To pay down debt, which of these should I pay off first?

1. Credit card debt: $3,500 at 19.99%
2. Car loan:  $21,000 at 2.9%
3. Line of credit debt: $9,930 at 6.75%
4. Personal loan: $48,000 at 7.5%

In about four years I plan to have it all will be paid off. But is it best to pay off the highest interest rate debt first and then work to the next highest? Or is it best to go to the bank and consolidate all loans and make one big payment? I have always been terrible with money but, even so, I never missed a bill payment or declared bankruptcy. Now, I’m looking for some guidance to pay down debt because I feel it’s time for me to be more responsible so I can enjoy a stress-free retirement.
–Paula

A. Paula, congratulations on your effort to pay down your debts. There are a few debt repayment strategies available to you, and which one to choose depends mostly on your personality.

Pay down debt with the debt snowball method

If you are motivated by accomplishments, then you might like the “debt snowball” strategy. Using this approach, you continue to make your minimum payments on your debt and then use surplus money to pay off the debt with the smallest dollar value first (regardless of interest rate), which, in your case, is your $3,500 credit card debt.

With the triumph of paying off one bill (such as your credit card bill), you take that monthly amount and apply it to the next smallest debt amount (the $21,000 in credit card debt, in your case), and start the process again until all outstanding debt is repaid.

The debt avalanche method

Maybe, though, you are motivated by saving on the interest you are paying? In that case, you would use the “debt avalanche” strategy, where you pay the minimums on all debt but pay any surplus money each month to the highest interest rate debt first—regardless of amount. In your case, Paula, that would be the $3,500 credit card debt you have at an interest rate of 19.99%. Once you’ve paid that off in full, then you pay off the next highest rate debt (the $48,000 personal loan at 7.5% in your case), and so on, until all of your debt is paid off.

Each strategy to pay down debt has its own good points. For instance, the debt avalanche strategy saves you more money in interest costs, while the debt snowball approach may keep you more motivated based on the quicker, small successes along the way. Setting timeline goals, which detail exactly how long you will take to pay off each debt, will help to keep you focused so you keep pursuing your goals.

Using a debt consolidation loan

Still, if you prefer a more structured system to pay down debt, maybe a consolidation loan would work best. It gives you a fixed interest rate and a fixed payment amount—usually paid every month—over a fixed period of time. This may allow for better cash flow planning because you will know exactly what amount your debt payment will be each and every month for a very specific period of time.

Above all, think about how great it will feel when your debt is repaid and eliminated. Keep this top of mind as you inch your way down to zero debt and, eventually, a longer-term savings plan.

Janet Gray is a fee-for-service Certified Financial Planner with Money Coaches Canada in Ottawa. 

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