- Get Out of Debt
The debt snowball and debt avalanche methods can help you pay your debts quickly and with minimum fuss. They are relatively simple strategies that all debtors can employ and they work for multiple types of debt, including credit card debt, student loan debt, and personal loans.
But how do these methods differ from one enough, is a debt snowball plan better than a debt avalanche one, how can they help with debt reduction, and are these debt payoff methods the only ones available?
What is the Debt Snowball Method?
The debt snowball method focuses on repaying the smallest bills first. These bills are the proverbial “low hanging fruit”, and clearing them can improve your financial situation, give you a morale boost, and gradually increase your credit score.
You can use a debt snowball calculator to better understand how it will benefit you, but in simple terms it’s a payoff strategy that aims to help you build momentum, focusing more on the accounts that will clear with the least amount of effort as opposed to the ones doing the most damage.
What is the Debt Avalanche Method?
The debt avalanche method focuses on the debt with the highest interest rate. As with debt snowball, you still need to meet your monthly payment obligations, but any extra money you have should then be used to reduce the debt with the highest interest rate.
This may be medical debt or credit card debt, it all depends on your circumstances.
As an example, let’s imagine that you have a $5,000 car loan with 5% interest; a $10,000 debt consolidation loan with 8% interest, and a $3,000 credit card balance on which you’re paying 20%. Although the credit card balance is the smallest of these debts and likely requires the lowest monthly payment, it has the highest interest rate and should be your priority.
Pros and Cons of Debt Avalanche vs Debt Snowball
On the surface, it makes more sense to focus on the highest interest rate debts first, which means debt avalanche is a better option than debt snowball. It should help you to save more money in the long run—reducing minimum payments and bringing the total interest down—and will allow you to get the most troublesome debt out of the way.
But if that’s the case, what’s the point of the debt snowball method? Why does it exist and how can it possibly be more beneficial then debt avalanche?
Debt snowball works because it clears small debts quickly, which gives you the motivation you need to continue. The power of that motivation should never be underestimated, as it could be the difference between paying off your debts in a couple of years or struggling with them for decades to come.
Let’s imagine that you’ve been unwell for a few weeks and have spent most of that time in bed. You have accumulated an endless number of chores and while you don’t feel like doing any of them, you know they need to be done to get back on track.
What do you do?
Do you choose the biggest chore first, such as scrubbing the toilets clean or painting your house, or do you focus on the smaller ones, such as taking the bins out? In the first instance, you’re beginning with the biggest and hardest chore, which means it will take you longer, require more willpower and perseverance, but will ultimately make life easier for you. In the second instance, you’re getting the little things out of the way so you can work towards the bigger ones.
This is essentially how the debt snowball and avalanche methods work—the latter makes more sense in the grand scheme of things, but when you’re struggling, the former seems more achievable.
How Do These Methods Work?
These methods only work if your debts are manageable and you’re able to meet more than the minimum payments every month. After all, you can’t make extras payments if you don’t have extra money.
Unless your debt to income ratio is maxed out, you should have some additional funds at the end of the month to put towards the debt. This is true for the vast majority of debtors. The issue is not that the money doesn’t exist, but that they don’t see a point in using it to pay off debt.
Paying more money towards your debts can feel like throwing good money after bad. If you’re only required to pay $200 a month then why give them $600? You could put those additional funds into a savings account or even use them to prepare for three months of minimum payments.
How Additional Payments Help to Pay Off Debt
To understand why this strategy is essential you need to understand how debt works. If you have a $10,000 loan or credit card debt and you’re making a $400 monthly payment, more than $300 of that will go toward interest, which means you’re barely making a dent in the principal. The older the debt is, the greater your principal payments will become in relation to interest, but if you increase those monthly payments from the outset, you could reduce that principal immediately.
If you have a $10,000 loan with a 7% interest rate and a term of 7 years, you can expect to pay $166.23 a month and over $4,100 in interest over those 7 years. Pay just $50 extra a month and you can reduce the total interest by over $1,400 and shorten the loan term by 2 years. Increase the monthly payment by $150 and you’ll drop 4 years from the loan term and save $2,500 in interest.
Every time you pay more than the minimum monthly payment, you’re clearing more of the principal, which reduces the interest and the compounding interest and greatly decreases the total cost of the loan.
How to Choose Between the Two
If you have a mathematical mind, you can run some calculations to determine which debt pay off strategy will suit you best. Will debt snowball create higher minimum payments, will debt avalanche be more effective at clearing the debts that have the most impact on your credit score?
Calculate your projected earnings and minimum payments over the next few years and see which one will help you to pay off debt with the least interest and fuss.
There are many other debt payoff methods as well, including everything from debt consolidation to bankruptcy and more. Take a look at our Debt Payoff Strategy guide to learn more and discover which option is right for you.
Source: pocketyourdollars.com