Debt reduction works by consolidating all non-secured debts, such as credit cards and medical and tuition bills into one monthly payment, usually substantially lower than the combined payments a debtor is currently making.
The way that debt reduction works, is that the consumer pays the agreed upon monthly amount to the consolidation company and gives them authorization to make payments to the individual creditors on their behalf. The company negotiates lower interest rates, or sometimes, zero interest. Creditors are sometimes willing to make such arrangements, because they are more likely to receive payments on time from a debt relief organization than an over-burdened consumer.
There are many debt-reduction strategies you can follow, but here are two of the most popular:
The Snowball Method This is the method personal finance and debt-reduction guru Dave Ramsey preaches. With this strategy, you start by paying the minimum on all debts and allocate additional debt payments toward the debt with the lowest balance. This method allows for immediate gratification, motivating you to keep working on paying off your debts. But because the debt with the lowest balance may not necessarily be the one with the lowest interest rate, you might not be saving as much interest over time using this method. However, since a lot of financial success comes from your behaviors, this method allows for some quick wins—which may help you stay motivated over the long haul.
The Avalanche Method This method suggests that you allocate any additional debt payments toward the debt with the highest interest rate while simultaneously paying the minimums on the rest of your debts. You continue this method—adding the entire additional payments to the debt with the highest interest rate debt—until the debt is completely paid off. Then you move to the next-highest interest rate debt and allocate any additional debt payments toward it, while still paying the minimums on the rest of your debts. Mathematically speaking, this strategy will save you the most money over time, since you’ll be paying the higher-interest debts before lower-interest ones. However, it may not allow for the immediate gratification of the Snowball Method.
Best way is to follow a combination of both methods. Start by paying off the debt with the lowest balance, then move on to the debts with the higher interest rates and continue to stick to the Avalanche Method from that point forward.