5 Ways To Get Out of Debt – Or Pay off a Hefty Loan

Debt is a problem that we all face. Whether it be student loans, credit cards, or monthly car payments we all encounter debt in some shape or form. Despite this, having any kind of debt will seriously impede your ability to achieve financial freedom. That's why it's imperative to get out of debt as soon as possible. In this post, I share 5 ways to get out of debt. Each of them has its own benefits and disadvantages, but definitely consider them all before committing to one. Ready to get rid of your debt? Let's dive right in!

Why Is Repaying Debt Important?

Before we jump in, I want to start with a quick retelling of an old parable. You might have heard it already, but it involves a king, a chessboard, and a few grains of rice… It goes something like this:

There's a king who loves to play chess. To satisfy his passion, he challenges all the people of his land to play against him and whoever wins will get whatever reward they can name. An old sage comes to the king and offers to play him. When asked what he wants as a reward if he wins, the sage says that he just wants a few grains of rice paid to him in a certain way.

If the sage won, he wanted the king to put a single grain of rice on the first chess square, and double it for every consequent chess square. When the king heard this, he laughed as this hardly sounded like any good reward. After all, it's just a few grains of rice. So he agrees.

They play and sure enough, the sage wins. Having lost the game, the king starts the payment process of the rice grains, but soon realizes his fatal mistake:

• By the 20th chess square, he would have to pay the sage more than 1,000,000 grains of rice
• By the 40th chess square, he would have to pay more than 1,000,000,000 grains of rice
• And by the 64th chess square (the full board), he would have the pay over 9,000,000,000,000,000,000 grains of rice! That's nine quintillion or nine billion billion grains of rice, which is allegedly more than if the entire world was covered in a 1-foot thick layer of rice.

Why Is This Important?

This is an important story because it shows how our brains are not built to handle exponential growth. If I told you to add 7 to itself 10 times, you could do that instantly (7 x 10 = 70). But if I told you to MULTIPLY 7 by itself 10 times, you'd have a lot more trouble with it (the answer is 282475249 in case you wanted to know).

Most institutions of debt use this to their advantage through something called Compound Interest. The debt looks innocent and easy to pay at first, but over time if left alone, it grows and grows and grows until it is way more than the original amount. Like the king in the story, too many people agree to something that they don't fully understand and get punished heavily for it later on.

However, there is a silver lining. Compound interest works both ways and can be used to your advantage through investing. With investing, instead of OWING more and more, you will be MAKING more and more. But, alas, investing is useless if you have tons of consumer debt dragging you down. It's like trying to drive with one foot on the gas and another on the brakes. So, let's find out how to pay off debt, and then we can start investing and growing your money.

1. The Do-nothing Method

This is by far the most popular method of debt repayment. So many people all over the world consistently apply it. What is it you might ask? Well, the Do-Nothing Method is when you have piles of debt and instead of dealing with the problem, you ignore it and hope that it goes away.

You might laugh, but need I remind you that the United States consumer debt level is at $14.3 trillion, and rising every year. People simply don't pay off their debt. This can be for various reasons, including being overwhelmed or not understanding the consequences, but needless to say, tons of people are just ignoring their debt problems.

Pros of the Do-Nothing Method:

• Can spend money on other stuff
• Don't have to worry (in the short-term) about money issues

Cons of the Do-Nothing Method:

• Debt is left unattended and grows to massive amounts over time
• Potential wage garnishes and house foreclosures in the future
• Broke in the future and spending life paying off debt
• Unhappiness

2. Highest Amount Method

Do I have your attention yet? Ok good, let's get into some actual debt repayment methods.

Before we go through any of these methods, I want to preface it by saying that this is with money that is leftover AFTER you have made your minimum payments. You should always try to pay off all of your debt, but truly at least pay the minimum. If you don't, there could be even higher penalties on your money.

Alright, now that that's out of the way, the Highest Amount Method is when you pay off your debt in accordance with the dollar amount that you owe.

For example, let's say you have 4 different forms of debt:

• Student loans: $80,000 at 2% interest (we'll talk about interest a little later)
• Car loans: $20,000 at 3% interest
• Credit card debt: $3,000 at 20% interest
• Mortgage: $100,000 at 5% interest

The highest amount method is when you would look at all these, and try to pay off the highest dollar amount debt figure first. In this case, it would be the $100,000 mortgage. Then after that's paid off, you would pay off the student loans, car loans, and finally credit card debt.

Pros of the Highest Amount Method:

• Feels intuitively right
• “Eating the Frog First” so that the debt repayment journey gets progressively easier as you go along
• Something is better than nothing

Cons of the Highest Amount Method:

• Debt is accumulating on other higher interest rate loans
• Can end up paying more money than other methods

3. Rain Shower Method

This method is pretty simple, and most people (out of those who pay their debt back) probably stick with this one. The Rain Shower Method is when you pay off your debt equally.

Let's take the same 4 sources of debt from the previous method: student loan, car loan, credit card, mortgage. And let's also assume that after paying your minimum balance you have $2000 left to pay off your debt. Using the Rain Shower Method, you would split up the $2000 into four pieces and pay $500 towards each one of your debt sources.

Pros of the Rain Shower Method:

• Don't need to think about it
• Easy to apply

Cons of the Rain Shower Method:

• Could be unmotivating as it will take a long time to pay off all debt
• If you lose motivation, you might quit in the process

4. Snowball Method

This is Dave Ramsey's method of paying off debt, and it's really effective. Put simply, the snowball method is paying off the smallest dollar amount of debt first, and then paying off the next smallest, until all your debts are gone.

Using the same 4 debts from above let's test this out:

• Student loans: $80,000 at 2% interest (we'll talk about interest a little later)
• Car loans: $20,000 at 3% interest
• Credit card debt: $3,000 at 20% interest
• Mortgage: $100,000 at 5% interest

First, you would pay off your credit card debt because it is only $3000 dollars. This might take you only 3 months, and then it's gone and you only have 3 items left so you're motivated to continue. Next, you pay off your car loans, and you only have 2 items left. With freed up money from the saved interest on your credit card and car, you pay back your student loan faster, and then finally clear your mortgage.

That is Dave Ramsey's Snowball method and it works so well because of psychology. When you try to pay off your biggest loans, oftentimes you'll get discouraged and just stop altogether. On the contrary, when you pay off your smallest loans first, it gives you momentum and keeps you motivated so you can pay off the rest.

Pros of the Snowball Method:

• Psychologically works
• Keeps you motivated so you're more likely to stay committed to the plan
• High success rate

Cons of the Snowball Method:

• There are still more efficient ways to pay off debt

5. Highest Interest Method

Last, but not least, we have my personal favorite: the Highest Interest Method. This method involves looking at your interest rates and paying off the loan which has the highest interest rate first and then working on your other loans. I like it so much because it mathematically makes the most sense.

Imagine you are the king who has foolishly agreed to pay double every chess square of rice but realized your mistake. What's the one factor you can change that can save you the most rice? The multiplier! If instead of double every chess square, you managed to negotiate to 1.7 every chess square, you would save yourself BILLIONS of rice grains. If you managed to negotiate down to a 1x multiplier, you would only need to pay 64 grains of rice… The difference between a 1x multiplier and 2x multiplier is 64 vs 9,000,000,000,000,000,000!

Paying off your highest interest rate debt first is like lowering your own multiplier. It will save you LOTS of money in the long run.

Let's take a look at this example:

• Student loans: $80,000 at 2% interest (we'll talk about interest a little later)
• Car loans: $20,000 at 3% interest
• Credit card debt: $3,000 at 20% interest
• Mortgage: $100,000 at 5% interest

Here, you would pay off your credit card debt first because it's at 20% interest, then pay off your mortgage (5%), then car loans, and finally student loans.

Pros of Highest Interest Method:

• Saves the most money overall
• Usually smaller amounts have higher interest rates so in line with the Snowball Method psychology

Cons of Highest Interest Method:

• Could maybe be demotivating if you have a huge loan with a high interest rate

Stay Out of Debt

In this world, there are such things as good and bad debt. Good debt is debt that you use to buy assets that will make you money.

For example, if you bought a rental property with debt but the rent you receive covers all minimum and interest payments, AND still manages to bring you cash every month… that's good debt! Most people, however, do not acquire good debt and instead have bad debt.

This is debt that's used to buy stuff that won't make you money: designer clothes, expensive meals, fancy cars. This kind of debt is the kind that keeps people trapped in their 9-5 for the rest of their lives. You want to avoid this kind of debt like the plague.

Even though I just showed you 4 ways to pay off your debt, the best method of them all is to not get into debt in the first place. And once you're out of debt, DEFINITELY don't go back.

Get Started Now!

Debt is so scary because too often we underestimate its power. Just like the king and his grains of rice, we can't fully grasp the power of compound interest and end up signing up for mountains of payments we didn't agree to. A quick recap on ways that we can pay it back:

1. Don't
2. Pay it back starting with the highest dollar amount
3. Split payments amongst all sources of debt
4. Pay off the smallest dollar amount first
5. Pay off the highest interest rate first

If you have debt, it's a good idea to start repaying it as soon as possible (pick one of these methods!). And if you don't, try to stay out of bad debt as much as you can. Without any debt, you become one step closer to being financially free.

Do you have debt you don't know how to repay? What methods do you use to pay off debt? What do you think about the idea of compound interest? 

This article was produced and syndicated by Wealth of Geeks.