Snowballs or Avalanches: Which Debt Reduction Strategy Is Best for You?
Are you in debt? Well, according to Transunion, many of us are — at least when it comes to credit cards.
If you answered "yes," then my guess is that you really want to get out of debt. (See also: 6 Painless Steps to Eliminate Debt)
Once you come to this decision and begin looking for ways to get out of debt, you'll likely find two methods:
- The Snowball Method
- The Avalanche Method
Let me briefly describe both — and which one is better.
The Snowball Method
This was made famous by financial author Dave Ramsey. In it, you list all your debts from the smallest balance to the largest balance — regardless of the interest rate. You begin by paying the minimum amounts on all debts and send any extra money to the debt with the smallest balance. (See also: A Guide to the Snowball Method)
Once your smallest balance is paid off, you take that payment, along with any extra money you have, and apply it to the debt with the next smallest balance. Then you continue this process until all of your debts are paid off.
The benefit you get from using this method comes from seeing one of your debts paid off sooner. This, in turn, can provide an emotional boost.
Let's face it. Sometimes, the road to debt freedom can be a long one. With the Snowball Method, you get a quick win that'll provide the motivation you need to continue the process of getting out of debt.
The Avalanche Method
With this method, you do things a bit differently. Rather than listing all your debts from the smallest balance to the largest balance, you list your debts from the highest interest rate to the lowest interest rate — regardless of the dollar amount of the debt. You begin by paying the minimum amounts on all debts, and send any extra money to the debt with the highest interest rate.
Once your debt with the highest interest rate is paid off, you take that payment, along with any extra money you have, and apply it to the debt with the next highest interest rate. Then you continue this process until all of your debts are paid off.
Unlike the Snowball Method, this doesn't get you paying off individual debts as quickly. But it does benefit you by saving you the most amount of money in terms of interest paid. And it gets you completely debt-free sooner.
So Which Method Is Better?
Well, both methods are effective — as long as you stick to the plan. (See also: How to Stick to Personal Deadlines)
The Snowball Method has worked well for many people, as Dave Ramsey fans will attest. But from a savings standpoint (in terms of time and money) — and with all due respect to Dave Ramsey — the Avalanche Method is the clear winner.
Let's take a look at an example.
Suppose you have the following three debts:
- $5,000 student loan, 3.75% interest, $50 minimum payment
- $11,000 credit card, 14% interest, $120 minimum payment
- $25,000 credit card, 15% interest, $480 minimum payment
Let's assume you scrimp and save and find a way to pay an extra $350 each month toward your debts.
If you used the Snowball Method, your first debt would be paid off in 13 months. You'd be completely debt free in 57 months, and you'd pay a total of $15,792.45 in interest.
But if you used the Avalanche Method, your first debt would be paid off in 39 months. You'd be completely debt free in 55 months, and you'd pay a total of $13,149.01 in interest. (See also: How to Pay Back Student Loans Faster)
In other words, that's a savings of 2 months and $2,643.44 in interest with the Avalanche Method.
If you want to run the numbers on your own debt situation, you can download this calculator for free.
But Which Method Is for You?
If you need to see the visible progress of having a debt paid off and you're not as concerned about numbers, then the Snowball Method may work for you.
But if you're willing to be more patient, so that you can save the most time and money, then the Avalanche Method is the clear winner. Staying focused on this end goal is the key to your success.
A Hybrid Approach
What if you don't like either method? Do you want a bit of the best of both worlds?
If so, consider paying off the smallest balance first. After that, switch to the highest interest rate next.
With this method, you get the quick win by seeing one of your debts paid off in a shorter time frame. And you also save a little bit more money than you would if you stuck with the Snowball Method.
Here's how your results would look.
If you used the Hybrid Approach, your first debt would be paid off in 13 months. You'd be completely debt-free in 57 months, and you'd pay a total of $15,493.87 in interest.
In other words, you'd pay off your first debt and be completely debt-free in the same amount of time as compared to the Snowball Method. But you'd also save an extra $298.58.
So the bottom line is that all methods work. But again, if you want to save the most amount of time and money, use the Avalanche Method.
If you climbed (or are climbing) out of debt, which method did you use?