How to Get Out of Debt: Credit Cards, the Avalanche and the Snowball

Debt isn't good or bad on its own; it's a tool. A reasonable mortgage or a loan for a business that already makes money can improve your life. A credit card that only gets minimum payments can quietly drain it for a decade. In this lesson you'll learn how to read the real cost of any debt, why the minimum payment is designed to keep you paying, and two proven methods to get to zero.

Debt that helps and debt that hurts

• Debt that can help pays for something that holds value or produces income, at a reasonable rate, with a payment you can comfortably afford: a home, a degree with solid job prospects, equipment for a business that already works.
• Debt that hurts pays for things that are gone before the debt is: vacations on a credit card, clothes and takeout carried month to month, payday loans, a phone upgrade financed over 36 months.

APR: the real price tag of debt

Lenders like to advertise the monthly payment because it looks small. What you should compare is the APR (annual percentage rate). Under the federal Truth in Lending Act, lenders must disclose it, and for most loans it includes not just interest but certain fees, such as origination fees. A few things to know:

• Credit cards charge interest daily. The daily rate is the APR ÷ 365. Pay your full statement balance by the due date and most cards charge no interest on purchases at all (the grace period).
• Different balances, different APRs. Cash advances usually carry a higher APR, a fee and no grace period. Promotional 0% rates expire.
• A lower payment can mean a higher total cost. Stretching a car loan from 48 to 72 months lowers the payment but adds months of interest.

The minimum payment trap

Take a $5,000 credit card balance at 22% APR, with no new purchases. A common minimum payment formula is the month's interest plus 1% of the balance, with a $35 floor. That starts at about $141.67 and shrinks as the balance shrinks, which is exactly why it takes so long. Here's what happens with different payments (interest estimated monthly):

At 22% APR, the first month's interest on $5,000 is about $91.67, so a $100 payment barely dents the balance: you'd pay more in interest than you originally owed. Going from the minimum to a fixed $300 cuts the payoff from 16 years to under two and saves roughly $6,650. Every extra dollar you pay today saves several in interest. Your statement must show a "minimum payment warning" box (a requirement of the 2009 CARD Act) with how long the minimum would take; read it once and it's hard to forget.

A five-step plan to get out of debt

1. Stop digging

While you're paying off debt, don't add new consumer debt. Remove saved cards from shopping apps and, if you need to, freeze the physical cards (literally, in a cup of water, if it helps).

2. Make the full list

For every debt: lender, balance, APR, minimum payment and due date. Many people discover they owe more than they thought. Uncomfortable, but it's the starting line.

3. Build a starter emergency fund

With $1,000 to $2,000 set aside (lesson 3), the next flat tire won't send you back to the credit card.

4. Pick a method and attack one debt at a time

Pay the minimum on everything and throw every extra dollar at one target. When it's gone, roll its payment into the next one. There are two ways to choose the order:

Here's a real comparison. Darnell, a warehouse supervisor in Memphis, has three debts and can put $900 a month toward them:

After minimums he has $392 extra each month. With the avalanche, the extra goes to the Visa (26.99%); with the snowball, to the store card (smallest balance). Both plans finish in 21 months. The snowball wipes out its first debt in month 4; the avalanche's first payoff comes in month 13 but costs less in total:

Paying only the minimums would take 63 months. Either focused plan saves more than $5,000 in interest; the difference between the two methods is just $83. The best method is the one you'll stick with to the end.

5. Lower the interest rate

• Call and ask. If you've paid on time, ask your card issuer for a lower APR or a hardship program. It takes ten minutes.
• Balance transfer card. Some cards offer 0% intro APR for 12 to 21 months, usually with a transfer fee of 3% to 5%. Move $6,000 with a 3% fee ($180) to an 18-month 0% offer and you'd need $6,180 ÷ 18 = $343.33 a month to clear it before the promo ends.
• Consolidation loan. A fixed-rate personal loan at a lower APR that pays off several cards. It only works if the APR is clearly lower and you stop using the cards; otherwise you end up with the loan and full cards again.
• Nonprofit credit counseling. Agencies affiliated with the National Foundation for Credit Counseling (NFCC) can review your budget and may offer a debt management plan with reduced rates.
• Federal student loans have repayment options you'd lose by refinancing them with a private lender; check StudentAid.gov first.

Your credit history matters

Lenders check your credit reports at Equifax, Experian and TransUnion. Paying on time, keeping your card balances low compared with your limits and not applying for lots of credit at once build a strong FICO score, which means lower rates on car loans and mortgages. You can check all three reports free every week at AnnualCreditReport.com. You'll go deep on this in lesson 13, and our guide on how to improve your credit score has quick wins.

Summary

• Compare debts by APR and total cost, never by the monthly payment alone.
• Minimum payments can stretch a $5,000 card balance past 16 years and cost more than the original debt.
• Stop adding debt, list everything, build a starter fund and focus extra money on one debt at a time.
• The avalanche saves the most interest; the snowball gives quicker wins. Both work.
• Balance transfers and consolidation only help if you stop using the cards.

Next lesson: Managing Irregular Income: Freelancers, Gig Workers and 1099 Contractors. You'll learn to budget on uneven income, pay yourself a steady salary, set aside quarterly taxes and price your work.