These days, living in debt is an all-to-common lifestyle that most of us have accepted as “normal.” But if it is your aim to tackle that debt and get to a better place financially, then this is a resource you won’t want to pass up. Debt can feel like an overwhelming thing, but it doesn’t have to be, especially with a solid strategy in place.
The most well known debt payoff strategies are the debt avalanche and the debt snowball. Although similar, there is one main difference between them. Let’s explore them and discover how they can help us eliminate debt for good.
Debt Avalanche
This strategy focuses on paying off debt with the highest interest rate first. The logic behind the avalanche is that it will typically save more money in interest over time. The reason this is possible is because by tackling the debt with the highest interest rate first, you avoid compound interest. To understand the importance of compound interest, read my post here. This strategy is a great choice if your motivation is based on the facts. If savings money on interest motivates you once you see the math and how much you’d save, this may be the right strategy for you.
Debt Snowball
Similar to the avalanche, the debt snowball lists all debts owed, but focuses on the balance owed versus the interest rate. The key difference with this strategy is the emotional energy that drives the momentum. By paying off the debt with the smallest balance first, you can gain momentum pretty quickly and keep rolling over that monthly budget surplus into the next debt on the list. By paying off the smaller balances quickly, your motivation and enthusiasm will soar. In terms of the math, the snowball doesn’t always save the most money, but rather plays off your feelings to keep you motivated.
Before you start…
Now that you have a good understanding of the two different strategies, there’s one last thing to tackle before starting.
Here me when I say that this step is absolutely crucial to the success of your debt payoff. This step, if skipped, is sort of like running a marathon without first tying your shoes.
The crucial step I’m referring to is your budget, or your written financial plan. If you are clueless where to start, check out my post here where I walk you through creating a plan for your money each month. The budget reveals your monthly payments for each debt, all in one spot. It will give you a birds’ eye view of your financial picture before focusing on something like debt payoff.
Still not sure which method to go with? There are so many debt payoff calculators online that can help you compare which debts would be best to pay off first, based on the interest rates and length of the loan. Try a debt payoff calculator, like this one here.
Personally, when I had a lot more debt and was in the thick of making multiple payments, I used a combination of both strategies. This is especially useful if the debts have identical or similar balances, but substantially differing interest rates. If I had a debt, like a student loan, that had the same interest rate as another student loan, I would choose the loan with the higher balance to payoff first. Now that I only have one loan left, besides my mortgage, things have gotten much simpler.
Pay off using Debt Avalanche
To start using the debt avalanche method, sort each debt according to its interest rate. List the debt with the highest rate first. Disregard the balance, here.
For example:
Credit card A: 19% interest rate, $40/month, balance of $3,500
Credit card B: 18% interest rate, $35/month, balance of $1,000
Car payment: 6.5% interest rate, $275/month, balance of $6,500
Student Loan A: 6% interest rate, $50/month, balance of $12,000
Student Loan B: 4.5 interest rate, $50/month, balance of $11,000
Medical debt: 0% interest rate, $50/month, balance of $900
Once your debts are in order, refer to your budget for the monthly minimum balance for each debt. Pay the minimum balances due for that month for each debt. After you pay all the minimums for the month as well as all your other bills, use any extra money to make an additional payment to the first debt on your list. When you apply that extra cash to the first debt on the list, you will pay the debt with the highest interest rate off quicker.
Pay off using Debt Snowball
In the Debt Snowball payoff method, the same concept applies, but with a slightly different focus. In this method, it doesn’t matter how high or low the interest rate is. Instead, the amount owed, or the balance, determines the order. To follow the example above, here’s how to arrange your debts using the snowball method:
Medical debt: 0% interest rate, $50/month, balance of $900
Credit card B: 18% interest rate, $35/month, balance of $1,000
Credit card A: 19% interest rate, $40/month, balance of $3,500
Car payment: 6.5% interest rate, $275/month, balance of $6,500
Student Loan B: 4.5 interest rate, $50/month, balance of $11,000
Student Loan A: 6% interest rate, $50/month, balance of $12,000
Notice the difference in the order as we switch from the avalanche to the snowball method.
Neither method is worse or better than the other. It all comes down to preference and personality. If the quick win motivates you, then tackle those smaller balances first. Your snowball will gain size and momentum as you approach the largest debt. On the contrary, if the amount of money you’ll save in interest (and overall) motivates you more, then the avalanche is most likely your style.
Regardless of the method you use, getting your debts in one place can really help you keep focused and stay the course. Arranging your debts in a way that make sense to you, will only lead you closer towards financial stability. Either strategy works, so don’t stress over the decision. Just pick one and go with it. You can always switch gears if the method you chose isn’t as motivating as you first thought. All that matters is that you have a strategy in the first place and you keep going!