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The average credit-using American household is buried in debt, like 20-years-away-from-getting-debt-free buried!
Consider these averages for US households carrying the following types of debt according to Nerd Wallet:
- Student Loans: $49,042
- Auto Loans: $28,535
- Credit Cards: $16,061
- Mortgage: $172,806
How do your numbers compare? You may not even know off the top of your head. If you’re like most of us, you pay your bills as received and try not to think about the totals too much because it’s a giant downer.
Here’s the thing: debt itself isn’t the downer. In fact, as we point out in our 4 Ways to Use Smart Debt to Improve Your Life, it’s super useful to be able to borrow money to pay for big-ticket stuff like education and property. The real downer is interest.
What is interest?
Interest is the cost of borrowing money. Lenders don’t loan you money out of the goodness of their hearts. They loan you money so they can make money by charging you interest.
Interest is the real reason you want to get debt-free as quickly as you can. Every month you have the debt, you have to pay more interest. This is especially important with credit card debt because credit card companies charge notoriously high interest rates.
Side note: credit cards sometimes offer special 0% APR for promotions (APR stands for Annual Percentage Rate, so this means you pay 0% interest per year). These are AWESOME because you can borrow money interest free! But you have to be really careful to pay off the full debt before the special expires (usually 12 or 24 months) because if you don’t pay the debt on time, the card company can charge back all that interest you avoided during the special period. Yikes!
And we have more credit card hacks if you’re interested!
So what do I do about it?
Most of the time, we pay off our debts without much thought or planning, but taking 15 minutes to decide on a debt payoff strategy can save you thousands of dollars!
This post looks at 3 methods for getting debt-free: the Minimum Amount Due Method (we’re not going to call this a strategy – it’s the anti-strategy), the Beer Waterfall Strategy, and our favorite, the Champagne Waterfall Strategy.
1. The Minimum Amount Due Method
You guessed it! The Minimum Amount Due Method means paying the minimum amount due on each of your debts each month. I’m not going to pretend there are no advantages to this. I mean, 1) you don’t have to think about it, so that’s cool. And 2) you pay a small amount each month, so you have money available to do and buy other things.
But OMG, you will PAY for those advantages.
Let’s use those average American Household debt numbers and assign some reasonable interest rates and minimum required payments to them for an example. Actual interest rates and minimum payments vary depending on things like when you borrowed the money (rates change constantly), who lent you the money (companies can charge different rates), and your credit score (better credit scores always get lower rates). We’re also going to ignore the mortgage for now, cause most of us aren’t homeowners just yet.
If you pay only the minimum amount due on each of these debts, your $93,638 debt will cost you $157,480 and will take 20 years and 10 months to pay off. Holy S! What if you wanted to add a 30-year mortgage to the mix? How would you ever get debt-free?!
2. The Beer Waterfall Strategy
The Beer Waterfall Strategy means focusing on the debt with the smallest balance and paying the minimum amount due on the rest of the debts. By “focus on”, I mean you need to throw some extra money at it. Before you say, “but I don’t have any extra money to throw at it,” let me assure you, almost all of us have some extra money, we just need to re-prioritize to find it.
The most common source of extra money is your morning Starbucks. A $5 latte every weekday is $100/month! Not the latte type? There are a million other places to look. Do you normally meet the girls for brunch once a week to catch up? Change brunch to a walk in the park, pocket the $20 brunch savings, and boom! You’ve got an extra $80 at the end of the month to put toward this debt from that one change alone.
Here’s the brilliant part of the Waterfall Strategy: Once you pay off your first debt, the amount of the monthly payment you were making on that debt is freed up for future months, so it can be poured into the next “focus” debt. And when that debt is paid off, all that money can all be poured into the next debt in line. Just like the Beer Waterfall in the “Kings” drinking game! Beer Waterfall!
Added bonus: You get used to living without the money you’re spending on paying off these debts, so once you’re debt-free, you can swing that amount of money into savings every month and never miss it!
Back to the Example
Let’s use the same debts used in the first example, but add $200 per month to your focus debt. Of course if you can add more, you can pay the debt down sooner, but $200 is a big chunk of change for most of us, so let’s not get too crazy here! Using this Beer Waterfall, your $93,638 debt will cost you $121,391 and will take 7 years and 9 months to pay off. Compare that to the $157,480 total and 20 years and 10 months pay off date for the Minimum Payment Due Method. You’re saving $36,089! Ta-da!
THAT’S why it’s worth the time to strategize and the extra $200/month.
3. The Champagne Waterfall Strategy
The Champagne Waterfall Strategy makes one big improvement to the Beer Waterfall Strategy. It’s basically the same, but instead of starting with the smallest balance debt as your focus debt, you’re going to start with the debt with the highest interest rate. This strategy gets rid of the high interest rate debts first so you’re lowering your overall interest payments even more.
Using the same example debts we’ve been working with and the same extra $200/month payment from the Beer Waterfall, your $93,638 debt will cost you $118,895 and will take 7 years and 7 months to pay off. Compare that to the $121,391 total for the Beer Waterfall Strategy. Voila, you save an extra $2,496 just by rearranging the order of your debt focus.
Here are those numbers one more time for easy comparison:
Minimum Amount Due Method:
$157,480 total. Will take 20 years and 10 months. Total amount each month varies because you’re only paying the minimum each month (starts at $1,125 while you’re paying on all debts).
Beer Waterfall Strategy:
$121,391 total. Will take 7 years and 9 months. Total amount each month: $1,325
Champagne Waterfall Strategy:
$118,895 total. Will take 7 years and 7 months. Total amount each month: $1,325
Just look how much faster you can be debt-free!
And look how much less interest you have to pay!
Some of the girls we’ve talked to actually prefer the Beer Waterfall Strategy over the Champagne Waterfall. It’s satisfying to watch those debts disappear forever, and starting with the smallest balance makes them disappear faster in the beginning. So the girls felt more compelled to stick with it. And that’s totally fine. You do you. You’ll still be way ahead of the game compared to the no-strategy-minimum-payment-method.
And btw, these strategies aren’t anything new. People in-the-know have been using them forever, commonly calling them the Debt-Snowball and the Debt-Avalanche. The Beer/Champagne analogy is just more us at this stage in our lives. This is a perfect example to prove that anyone can manage their finances like a pro, we just need someone to show us the tricks!
Now that you know how this works, crunch your numbers and see how much you can save! We have a totally free, super fancy calculator for you. You just enter your debt, interest rates, and minimum payments into our Excel calculator, and it spits out a month-by-month custom payment plan!
Ready to learn more tricks? Level Up by reading our next post: The $831,751 Reason to Save for Retirement While You’re Young and Broke.
Feel like sharing?
Post your potential savings in the comments!