How to use this tool to choose the debt elimination method
The tool features a debt payoff calculator that compares the two most popular debt
repayment
strategies:
It also shows you the financial impact side-by-side in a chart. To use the tool, follow
these
steps:
-
Enter the Information of Your Debts
Select two debts (either credit cards or loans) you want to eliminate, input the
current
balance, interest rate (APR), remaining term in months, and scheduled monthly
payment
will be calculated automatically.
-
Prepayment Settings
Enter your monthly savings in cash after deducting all living expenses before
considering
any debt payment. Next, the scheduled debt payment is automatically summed up
from those
two loans. If the scheduled debt payment is greater than your monthly savings,
you are
unlikely to have more cash to make a prepayment. If you have extra savings left,
enter
the monthly amount you plan to allocate toward the extra debt payoff and input
any
one-time prepayment (e.g., from the bonus received).
-
Investment Yield Settings
Choose an investment yield if you alternatively save the cash for investment
rather than
make more debt repayment. In some circumstances, when your expected investment
yield is
higher than any interest rate of your debts, it makes more financial sense not
to pay
off any debts earlier. For example, when your credit card APR is zero in the
promotional
period or your mortgage rate is very low, saving your cash in higher yield CD or
Treasury Bills can earn more interest than the interest charged on your debts.
-
View Results of Calculation
The calculator will display how long it will take to pay off the debt, total
payments,
and interest savings for each strategy.
-
Check the Accumulated Savings
In the chart of "Change in Accumulated Savings", the blue line is the savings of
using
the Avalanche method minus the savings of no prepayment, and the red line is the
savings
of using the Snowball method minus the savings of no prepayment. The blue line
is always
better than the red line because you can always save more interest in the
Avalanche
method than in the Snowball method. However, there is another catch in this
chart.
When you see the ultimate savings in the Avalanche method are negative (less
than 0) in
the long term, in this case, the prepayment doesn't create more savings than no
prepayment. This is because your investment yield is higher than the interest
rates of
your debts. You may need to reconsider if it's worth it to repay the loan more
than the
scheduled amount.
-
Choose a Payoff Strategy
Whether you want to go with "Avalanche" (pay off high-interest debt first) or
"Snowball"
(pay off the smallest balance first), or not even prepay any debts at this
moment. You
should determine which strategy is best based on your situation, preference, and
persistence.