When it comes to debt, going into it is a breeze but getting out is like running a 5K race when your “training” consisted of donuts and Netflix. It’s hard, but with the right strategy getting to the finish line won’t seem so impossible.
There are two different types of methods you can use on your debt-free journey: the debt snowball or the debt avalanche. If you’ve been searching for ways to pay off debt, you might have seen these terms before but never really understood what they meant. In this post, I’m breaking down each method to help you determine which is best for you.
The Debt Snowball
When using the debt snowball method, you focus on paying off your smallest debt balance first. You will continue to make the minimum payments on your other debts, but all extra money should be used on the smallest balance to pay it off quickly.
For example, let’s say you have five debts:
- $15,000 auto loan
- $2,000 personal loan
- $6,000 student loan
- $7,000 student loan
- $9,000 credit card
You will start your debt-free journey by tackling your $2,000 personal loan since it has the smallest balance. After reviewing your budget to see where you can make cuts and adjustments to squeeze out extra cash, you allocate as much as you can towards this debt.
Once the credit card is paid in full, you will then rollover the money used on the personal loan to the next smallest balance in line. This process continues until all of your debts are gone.
You can “see” success quicker. This debt payoff method is popular for its quick wins. When you’re putting the majority of your money towards the smallest balance, you see the numbers drop a lot faster which helps you gain momentum.
You’re more motivated to continue paying debt. Starting out small results in quicker wins, and as your balance drops with each payment you get more and more pumped to continue on your journey. Once your debt is paid off, you’ve proven to yourself that you’ve got what it takes to kick debt to the curb. Suddenly, what once felt impossible becomes a lot closer in reach.
You may wind up paying more in interest. Your smallest balance may not necessarily be the debt with the highest interest rate. This means that, by only paying the minimum, you may end up paying out more in interest over the course of the loan.
The Debt Avalanche
When using the debt avalanche method you begin attacking the debt with the highest interest rate first. Contrary to the debt snowball, the amount of the balance does not matter.
Going back to the five debts example, let’s say these are your interest rates:
- $15,000 auto loan- 6% interest rate
- $2,000 personal loan- 5% interest rate
- $6,000 student loan -3.5% interest rate
- $7,000 student loan- 4.2% interest rate
- $9,000 credit card -20% APR (annual percentage rate)
Using this method, you will continue to make the minimum payments on the other debts but all extra money should be used to pay off the $9,000 credit card as quickly as possible. Once the debt is paid in full, you will rollover the money to the next high-interest balance.
You’re saving more money in the long run. Unless you have a 0% interest rate, your debt balance is accruing interest daily. As the balance decreases, so do the the interest charges.
You can shorten the time it takes you to become debt-free. Interest charges lengthen the time it takes us to pay off debt because our payments first go to interest and then to the principal balance. By getting rid of the highest interest rate, you’re ensuring that the majority of your payments go straight to the debt’s balance.
The debt balance may not budge as quickly. Depending on how high your interest-rate and balance are, it may take quite a bit of time to zero it out. This means that you won’t reap the benefit of quick wins and it’ll become easier to lose steam.
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So, which method is right for you?
The answer is…it depends. Everyone is different, which means one method may be more beneficial for you but not to the next reader. To help you determine which method is right for you, here are two things you should do:
Evaluate your interest rates. Interest rates can eat your paycheck alive and cost you your sanity. Speaking logically, if you’re someone carrying balances with crippling high-interest rates then it may be more beneficial to get rid of the most toxic debts first.
List all of your debt’s interest rates from highest to lowest, and calculate how much they’re costing you each month. If the amount you’re paying in interest is gobbling up over half of your payment then it may make sense to take the avalanche approach.
Be honest about your level of motivation. Paying off debt isn’t all about the numbers, as there are psychological factors that come into play as well. Ask yourself: Can I stay focused for a long period of time or do I need small victories to keep myself from going insane?
Using the debt avalanche requires a lot of patience because seeing progress does not come as easily. This method may be more beneficial to those who can focus on the big picture without needing little rewards along the way.
The debt snowball method is great for the instant gratification gang who needs to “see” that their efforts are making a difference. This will also include debt paying beginners and those who often find themselves on the verge of giving up when things gets tough.
Let’s face it, no one wants to throw their hard-earned money towards something that doesn’t appear to be getting them anywhere. Personally, I prefer to start from smallest to largest because I know that in order to keep going I need to see results rather quickly. Good thing is, you’re not obligated to continue using the same method for the rest of your debt-free journey. If you’re not sure which method you prefer, try testing them both out before you make a commitment.
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