Debt Talk: Avalanche vs Snowball
Credit card balances, mortgages, car loans, pay day loans, or even student loans. Most of us (if not all) have some form of debt. According to an analysis performed by the Federal Reserve bank of New York on US household debt, there is roughly $14-trillion in debt owed as of Q2 2019. Picture this, a world where you didn't have any debt payments to make. In my financial situation, that could free up $500 in student loan payments per month. For others it could be a few hundred because their car is paid off or have no credit card debt. But how do we get there? Today, we'll discuss two methods of debt repayment to pay down unwanted debt.
Method #1: Debt Avalanche
An avalanche is a mass of snow that falls rapidly down a mountain side. Just as it sounds, the debt avalanche method is an accelerated method of paying off debt. In this method, the debt that is a priority is the one with the highest interest. By tackling the debt with the highest interest, you are saving money on that compounding interest and ultimately time because the interest can prolong the loan. This could help save you hundreds if not thousands of dollars in interest using this method.
Let’s say for example you have credit cards with varying APRs of 5%, 18% and 25%, and minimum payments of $25. Using the avalanche method, you will make the minimum payments on each credit card and make an extra payment (e.g. $50) on the debt with 25% APR. After the 25% APR card is eliminated, you use the total debt payments ($75) from that debt along with the minimum payment (for a total of $100) to tackle the next highest APR debt. You will continue this process until all the debt is eliminated.
Method #2: Debt Snowball
In order to form a snowball, you must start small to pack the snow and continue to build on it. With the snowball method, the goal is to pay the smallest debt off first then move on to tackle the next smallest debt. In my opinion, the main advantage of the debt snowball is that it helps build your motivation during your debt repayment journey. With each small win you encounter, it can help you to continue to strive towards your goal of eliminating debt.
In this example, you have three debts with $150, $750, $5,000 balances and minimum payments of $25. Using the debt snowball method, you will make the minimum payments on each credit card and make an extra payment (e.g. $50) on the debt of $150. After the $150 debt is paid off, you use those debt payments ($75) allocated to that specific debt along with the minimum payments (for a total of $100) to tackle the next smallest balance of $750.
Whether you are using the snowball method or the avalanche method, both are great ways to pay down that unwanted debt. There are two questions you can ask yourself when choosing the right approach for you. Do I want to save time and money with an accelerated approach? Do I want to maintain momentum during my debt free journey process? Regardless of the method you use, paying down debt will give you peace of mind and it’ll free up some extra cash for you to reach other goals. As always, I want to hear from you! Do you have some unwanted debt that you want to pay off this year? Will the avalanche or snowball method work best for you?
Holding you accountable,
DWM