Debt Repayment: Debt Snowball vs. Debt Avalanche
1. Debt Snowball MethodThis is a debt reduction method, where the borrower decides to pay off multiple debts by starting with the ones with the smallest balances. When the smallest payments are cleared off, one then proceeds to the other. The debts with the most copious amounts are paid last when using this method. Debt snowball method is often used when repaying revolving credits such as the credit cards.
Debt Snowball Basic Steps
- List all the debts starting with the ones with the smallest dues to the ones with the largest balances.This is the main distinctive feature of this method. The order can only be determined by the balances only, and not the standing interest rates. If you have two which have very close figures, then the one with the relatively higher interest rate will be moved above.
- Start paying off the debts in the organized order. You can pay the minimum payable amount of the smallest debts then contribute a small amount the next one, until the settle them. However, note that some lenders especially the car companies or mortgage lenders will increase their rates when the borrower’s delays hence they must be contacted early enough so that they can only increase interest on the principal amount only
- Once you are done with the smallest debt payment, move on to the next one and repeat the chain until you settle all the debts.
Debt Snowball Example
|Creditor||Total Debt||Regular Payment||Regular + Extra Payment||New Payment|
- $500 medical bill (minimum payable amount of $50)
- $2,500 credit card debt with a minimum payable amount of $63
- $7,000 car loan with minimum pay of $135
- $10,000 student loan with a minimum payable amount of $96
Debt Snowball Pros and Cons
|Motivation – it feels good to see the progress of your debt repayments since you will only move to the next one you are done with the least. Seeing your hard work pay encourages you to stay on the track.||It will cost you more – As compared to the avalanche method, making the minimum payments even on the debts which have a higher interest will make you pay more in the long run.|
2. The Debt Avalanche MethodThis is a type of debt payoff plan, where the debtor assigns a sufficient amount of money so the minimum payment on each debt could be made. When the payment is made the debtor allocates remaining debt-repayment funds to the debt with the highest interest rate. And when the debt with the highest interest rate is finally paid off, the extra repayment funds go toward the next highest interest-bearing loan. The method is ongoing until all the debts are paid off.
Debt Avalanche Basic Steps
- List down all your debts, by starting with the ones with the highest interest rates. You will not be worried about the loan servicer or provider when using this method, but rather on the interest rates only. In most cases, the credit cards will top the lists due to their high interest rates.
- Once you have made a list, it’s upon you now to come up with a good plan of how much you will start contributing; this will depend on your level of income as well the minimal payable amounts of the debts.
- Pay the minimum of each debt, and then put the extra amount on the obligations with the highest interests. You can get extra money by looking for other income generating means to help you settle your debt quickly.
- Repeat the cycle every month. Eventually, you will settle all the debts if you plan well, follow your budget and maintain a good debt payment discipline.
Debt Avalanche Example
- Credit card loan with a balance of $7,500, minimum payment of $150 and interest rate of 18.99%
- Credit card two with a balance of $500, a minimum payment of $25 and interest rate of 9.99%
- A student loan of $15,000, the minimum payable amount of $150 and a 10% interest rate
- A car loan of $8,000, a minimum payment of $250 and an interest rate of 12%.
|Loan||Balance||Interest Rate||Minimum Payment|
|Credit card loan||$7,500||$150||18.99%|
|Credit card two||$500||$25||9.99%|
Debt Avalanche Pros and Cons
Which Method Should You Use?Well, personal finance is based on individual decisions. The key is, to be honest on your budget and use the method that won’t hurt you. However, itâ€™s okay to experiment both methods and see which one will; favor you. If the debt avalanche method seems quite appealing to you, then try it for several months. If you find out it’s not working well on you, switch to the snowball method and experiment it. With that said, consider these factors when choosing between the two:
- Your interest rate situation – If one of your debts has an incredibly higher rate than the others, then itâ€™s good to settle it first especially if it’s not possible to refinance it. This will free up your money to pay off the others.
- Your financial decision-making drive – If you are the type of people who are driven by emotions, then it would be wise to use the snowball method. As discussed above, the method is motivational since you can see the efforts of your hard work quickly.
Alice was born and raised in Compton, California. Then she studied at Yuin University, the place where she became passionate about researching the thin ropes between money and meaning. She is insatiably interested in peopleâ€™s potential, wondering why some succeed and others donâ€™t. Thus, the articles on her blog explore a multitude of seemingly unconnected things: money, psychology, entrepreneurship, creativity, spirituality, philanthropy, just to name a few.