Figuring out how to beat a game – any game – requires one basic principle. You have to know how the game is played. I’m not saying that you should treat getting out of debt like a game. You’re playing around with real life here, so I’m not suggesting that you play Russian roulette with your finances.
Everyone knows how to play Black Jack, correct? For those of you who are a little rusty, it may seem like the goal is to get the value of the cards in your stack as close to 21 as possible without going over, not necessarily, the goal is to beat the dealer. Most Black Jack players base their strategy on one simple rule – the dealer is required to hit until he gets to 17. Similarly, people who do well with their finances have one thing in common. They understand the basic principle of how creditors are able to charge interest. Creditors are only allowed to charge interest on outstanding principle; in other words, the actual balance of your debt. Let me explain …
Dave Ramsey, who we admire and respect, has a theory of getting out of debt that he calls “The Snowball Theory”. Basically, you take the total of all of the minimum payments to all your creditors (i.e. $2,500.00 / month) and plan on paying $2,500.00 / month until you are completely debt free. Here’s an article on Dave Ramsey, for reference:
As time goes, your minimum payments will start to decrease, assuming you don’t add new debt. As the minimums start to decrease you apply any additional money to the smallest debt, when the smallest is paid in full, start applying that additional money to the next smallest debt. Continue this until you are debt free. ($2,500.00 / month being applied towards debt less updated minimum payments as time goes = additional money being applied to debt). Any money applied towards debt above and beyond the minimum payment each month is called MARGIN. Creditors are only allowed to apply margin toward your principal balance – NOT interest or penalties. So anything you pay above the minimum payment is going directly to your principal balance and reducing the amount your creditors can apply interest to, right?
Now, we’re going to do some math. I know, I know. Just bear with me. The key to this game of getting out of debt is figuring out how we can maximize our margin. Remember, margin is only applied to principle balance and creditors are only allowed to charge interest to outstanding principle balance. The faster you pay down your principle balance, the less interest you pay and the faster you are debt free. So, the secret is, apply money above the minimum payments (margin) to the debt that will create the most margin for the following month.
Here comes the math:
Example: let’s say you have a house payment of $1,000.00 per month and you pay 1,100.00 the first month. The next month your house payment will still be $1,000.00, you have NOT created any margin.
Now let’s say you have a credit card with a balance of $15,000.00 and your minimum payment is $300.00 per month and the first month you pay $400.00. The following month your minimum payment will have gone down to approx. $290.00 you have created $10.00 of margin in just one month.
Dave Ramsey is right. You CAN do this Snowball Theory yourself and it does work. However, Applying a little bit of algorithmic math, you can expedite the process exponentially. In other words, the fastest way from point A to point B is a straight line. With Mathematics we can show you the straight line to getting you out of debt. Plus, The cool thing is you have us here to do it for you. Stay tuned for more tips and tricks on winning the game of getting out of debt.