The two most popular debt repayment strategies people use to pay off debt include the “debt snowball” and “debt avalanche” methods.
Consumer debt has become a big problem in North America, especially in the United States. As of last year, Americans owed over $14.96 trillion, with an average consumer debt of $92,727.
Before digging into whether to choose between the debt snowball method or debt avalanche, it is important to note that your main focus should be getting rid of your debt.
While methodology matters, results matter the most, and you should choose whatever debt reduction strategy gets the job done for you and helps you reach debt freedom!
How To Pay Off Debt With The Debt Snowball Strategy
The debt snowball is a strategy to pay off your debt by starting off with your smallest balance. This debt repayment strategy was made popular by personal finance guru Dave Ramsey. This is how it works:
Step 1: list your debts from smallest to largest (ignore their interest rates and don’t include your mortgage).
Step 2: List the minimum monthly payments required for each debt to avoid going into default.
Step 3: Pay the minimum payment on each debt and direct any remaining funds to pay off your smallest debt.
Step 4: Repeat step #3 until the smallest debt is paid off.
Step 5: Put the total amount you were paying on the first smallest debt (i.e. minimum payment plus extra funds) towards clearing your next smallest debt. Rinse and repeat this step until all debts are paid in full.
The debt snowball method is an incremental momentum approach to paying off debt. It capitalizes on small wins giving you the motivation and energy to tackle even bigger debts and pay them off.
Debt Snowball Example
Let’s say you carry a total of $16,000 in consumer debt as follows:
|Credit Card A
|Credit Card B
|Total Monthly Minimum Payment = $455
Assuming you have sat down to review your financial situation and have drawn up a budget that would allow you to put $800 per month towards paying off debt.
Using the debt snowball strategy, you will plan to pay off your car loan first (smallest debt) and then work your way up until you pay off Credit Card B (largest debt).
Based on your $800 monthly budget, you will make $330 in minimum payments for Credit Card A ($80), Credit Card B ($150), Personal Loan ($100), and then attack your Car Loan balance with the remaining $470 (i.e. $800 minus $330).
With this approach, you will pay off your Car Loan in 5 months. Once you have paid this off, the $470 freed up will be used to pay off your next smallest debt (Credit Card A) for a total monthly repayment of $550 (i.e. $470 + the $80 minimum payment).
After paying off Credit Card A, you now focus on tackling your Personal Loan, and lastly, the remaining balance on Credit Card B.
Using the example above and the debt snowball strategy, it will take you 24 months to pay off all four debts, and you will make $2,805 in total interest payments.
Pros of Debt Snowball
1. Quick wins that can motivate you to pay off debt one account at a time. It is easier to see the end of the tunnel when you are hustling to destroy a $500 balance vs. a $5,000 balance.
2. Helps to focus on one task when you have multiple debts in different categories that can easily become overwhelming.
3. A research study by North Western’s Kellogg School of Management showed that “people with large credit and balances are more likely to pay down their entire debt if they focus first on paying off the cards with the smallest balances.” This boils down to the psychology and emotional mindset behind paying off debt and seeing the results as soon as possible.
Read more about Debt Snowball and Dave Ramsey’s Baby Steps.
Cons of Debt Snowball
1. You are likely to pay more in total interest fees.
2. it takes longer to become debt-free.
How To Pay Off Debt With The Debt Avalanche Strategy
The debt avalanche debt repayment strategy is also called “debt stacking.” Debt avalanche focuses on paying debts with the highest interest rates first. This is how it works:
Step 1: List your debts from highest to lowest.
Step 2: List the minimum monthly payments required to avoid going into default.
Step 3: make the minimum payments on all your debts and direct any remaining dollars towards paying down the debt with the highest interest rate.
Step 4: Repeat step #3 until the highest interest rate debt is paid off.
Step 5: Put the total amount you were paying on your highest-rated debt (i.e. minimum payment plus extra funds) towards clearing your second-highest-rated debt and so on until all debts are paid in full.
The debt avalanche technique is a rational approach to debt reduction that takes a hard look at the numbers and focuses on making lower interest payments overall.
Debt Avalanche Example
Using the same scenario we had for the debt snowball, let’s say you are owing a total of $16,000 as follows:
|Credit Card A
|Credit Card B
|Total Monthly Minimum = $455
With the same monthly budget of $800 for debt repayment and using the debt avalanche method, you will plan to first pay off Credit Card A (highest interest rate) and then make your way down until you wipe out your Car Loan (smallest interest rate).
To start, you will make $375 in minimum payments towards Card B ($150), Personal Loan ($100), and Car Loan ($125). The remaining $425 will go towards paying down Credit Card A.
After paying off Credit Card A in 8 months, you will direct these ‘free’ dollars (i.e. $425) towards paying down Credit Card B, such that monthly payments to this debt balance now totals $575 (i.e. $425 plus the minimum $150 payment).
This process goes on until you have cleared all your debts. Using the debt avalanche method, you will become debt-free in 23 months and pay $2,372 in total interest payments.
Pros of Debt Avalanche
1. You save money on interest payments. This is because you are tackling higher-interest debts first. Using our example, credit card A is a whopping 21% APR which is significantly higher than your car loan rate at 6.5%. The higher this credit card balance remains unpaid, the faster it grows.
2. You become debt-free faster. In the example above, you become debt-free 1 month earlier.
Cons of Debt Avalanche
There are no quick wins if your highest-interest debt is also your largest balance.
It is easier to become demotivated when your debt balance appears to not be budging despite your best efforts to pay it down.
Debt Snowball vs. Debt Avalanche
The debt snowball vs. debt avalanche calculator I used for the examples above shows that the Debt Avalanche repayment strategy wins the math. It shows that using the debt avalanche means you pay off your debts one month faster while also saving $432.77.
While the debt avalanche promises to save you money in the long run, debt repayment is not only about the numbers. To quote Dave Ramsey:
Personal finance is 80% behavior and 20% head knowledge.
The debt snowball method has worked for millions of people who are drowning in debt because it offers them quick wins and a chance to gradually change their behavior towards debt.
It may cost more, but you may find it easier to stay motivated when you see your smallest debt go down quickly, and you can cross it off your list for good!
When it comes to paying off debt, it is best to go with what works for you and gets your bills paid up. Using the debt snowball or debt avalanche does not have to be black and white. You can also combine the strategies to fit in with your situation.
One scenario where you should absolutely employ the debt avalanche method is for payday loans.
If you carry any of these loans with interest rates often exceeding 400% APR, you should definitely pay this balance off first, as it has the potential to totally wreck you financially.
Budgeting and Paying Off Debt
Paying off debt is hard. If you are going to succeed at it, you must plan ahead.
1. Start with a Financial Audit: Audit your financial life. List your expenses and income so you understand how your money comes and goes. List your debts.
2. Budget: Create a budget that is realistic and which provides for a monthly repayment of your debt. Remember that minimum payments will not cut it! Find the room in your budget to pay down debt. This may include finding ways to save extra money to get out of debt faster.
3. Increase your Income: One of the easiest ways to pay off debt is to earn more than you spend. I have listed more than 113 ways to make extra money. Don’t give in to lifestyle inflation when your income increases. Put your extra funds to work in paying down debt.
4. Keep Keeping On and Celebrate Your Wins: Stick to your budget and financial plan. Get help from professionals if you are feeling overwhelmed, unsure about what to do, or if debt consolidation is your best option. Don’t rack up any further debt. Remember to celebrate your wins along the way.
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