Debt Snowball or Debt Avalanche?

 

debt snowball

Debt Snowball or Debt Avalanche?

Paying off debt is no fun for anyone, especially if there’s a lot. However, paying off your debts will help you move forward in your life and not be burdened with the stress and health consequences debt can have on you. The debt avalanche and debt snowball methods are two useful strategies of getting that debt out of your life – but one may make a bigger impact on your debt repayment than the other. Here’s the difference.

 

Debt Avalanche

Suppose you have $500 to contribute to paying off your debts every month. The debt avalanche method prioritizes paying off your debts from highest to lowest interest rates in order to minimize the amount of interest you pay, while making minimum payments on all your other debts. After you pay off your highest interest rate debt, you move onto the debt with the next highest interest. As you pay off each debt, its minimum payment gets added to the monthly payment for the next debt, and by the time you get to your last debt, you’re taking huge chunks out of it each month.

Imagine these are your debts:

  • $10,000 line of credit at 5%
  • $8,000 Visa at 18%
  • $5,000 student loan at 8.5%

With the debt avalanche method, this is how you should prioritize paying off your debts:

  • Priority #1 – $8,000 Visa at 18%
  • Priority #2 – $5,000 Mastercard at 9%
  • Priority #3 – $10,000 line of credit at 5%

 

By paying off your Visa first, you’ll be able to drop your debt faster and pay less total interest, sounds great right? Here’s the snowball method.

 

Debt Snowball

The debt snowball method ignores the interest rates, and instead focuses on paying off your debts from the smallest to largest balances. You make your minimum payments on all of your debts, devote any leftover money to the debt with the smallest balance, and then once that debt is paid off, devote its previous monthly payment and leftover money to your next-smallest debt. The idea is that paying off your smaller debts sooner will give you confidence and momentum to stick with your plan until the end.

With the debt snowball method, this is how you would be prioritizing paying off your debts:

  • Priority #1: $5,000 Mastercard at 9%
  • Priority #2: $8,000 Visa at 18%
  • Priority #3: $10,000 line of credit at 5%

This behavioural-based method uses the power of quick wins to help you succeed in paying off your debts. Once you pay off that first debt, that small win will push you forward to knock down your next debt. However, using this method will lead you to pay more interest than you would using the avalanche method, so which one is really better?

 

debt pig

Looking at the numbers: Debt Avalanche vs. Debt Snowball

Using the debt avalanche to pay off your debt will save you the most money in interest payments. If you had the $500 to devote to paying off your debts and you would need to pay $50 for each card every month for minimum payments:

  • Time until debt free: 54 months (4.5 years)
  • Total interest paid: $4,526
  • Total paid: $27,518

 

With the debt snowball method, these would be your results:

  • Time until debt free: 56 months (4.7 years)
  • Total interest paid: $5,682
  • Total paid: $28,679

 

As you can see, you are paying more with the debt snowball method and it will take longer – the debt avalanche method is obviously the most rational strategy, so why is the snowball method even talked about?

The advantage of the debt snowball is that it helps build motivation for debt repayment, which counts for a lot more than you would think. It’s not easy to get excited about paying off your debts, and throwing large amounts of money towards debt every month is even harder if you can’t see quick progress. In fact, several studies have actually shown that the debt snowball method may be the better of the two:

 

Kellogg School of Management

This 2012 study of 6,000 people showed that those with large credit-card balances are more likely to pay down their entire debt if they focus on paying off the cards with the smallest balances first.

University of Michigan

This study from 2011 showed that participants tended to naturally follow the debt snowball method. However, when participants weren’t allowed to pay off the full account balance on smaller debts and were shown how much interest had accrued on each debt, they were able to focus on the higher-interest debts first.

 

What’s best for me?

The research shows that it’s much easier to stay motivated when you pay off your smaller debts first, even though based on the numbers, paying off your highest interest debts would make the most sense. If you’re wondering which method is the best for you, here are a few tips to help you decide:

 

Do the math

Figure out how much you need to pay for your own debts – sometimes doing the math and reminding yourself of it may help you make the most rational choice for yourself. In the example we used, there wasn’t a huge difference between the two methods, so going with the snowball method wouldn’t have that great of a damage to your finances. However, everyone’s situation is different, so be sure you’re confident that you are making the best choice for yourself.

 

Focus on one account at a time

Regardless of which method you choose to deal with your debt repayment, make sure that you are focusing on one account at a time. It will help pay off your debt more quickly and stay on track with your financial plan.

 

Don’t quit!

Getting out of debt is hard, trust us, we know. Make sure you keep on it, though, and try your best to keep yourself motivated – set aside time for yourself to relax, invest in yourself, and spend time with your family – the results are truly worth it!

 


If you found this article interesting, don’t forget to check out our other posts! 

 

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