If the end goal is debt freedom, you’ll need a plan for how to achieve it. Every year, thousands of consumers turn to two popular debt repayment strategies in order to get out of debt faster: the debt snowball method and the debt avalanche method.
How does the debt snowball method work?
The debt snowball method prioritizes your debts in order from smallest balance to largest. Personal finance author and personality Dave Ramsey first popularized the “snowball” method, and the supporting idea is how the method gets its name.
Eventually, as you pay off balances, you incorporate those minimum payments into the amount you put toward your next debt, much in the way a snowball rolling down hill gets larger as it accumulates snow.
Imagine you have the following debts. By listing them out from the smallest balance to the largest, here’s how you’d tackle them using the debt snowball approach.
- Credit Card #1 - $1,000 balance with a minimum monthly payment of $50
- Credit Card #2 - $4,000 balance with a minimum monthly payment of $100
- Student Loan - $30,000 balance with a minimum monthly payment of $350
You pay the minimums on all the cards, but then contribute the extra amount to the smallest balance.Then, when this amount is knocked out, both the first cards minimum payment, plus the extra monthly payment goes to the second balance. So, after credit card #1 is paid, then Credit Card #2 gets $350 when combining minimums from both cards plus extra.
With the help of a debt snowball calculator, you can see by contributing an extra $200 each month above the $500 in minimum payments, you’ll pay off the $1,000 balance in 5 months, the $4,000 card 13 months after that, and have all debts fully paid within five years.
How does the debt avalanche method work?
The debt avalanche method prioritizes paying off debts from the highest interest rate to the lowest. Because this method prioritizes paying down high-interest debt first, consumers are able to save more money and pay off debt faster as compared to the debt snowball.
Using our previous numbers, here’s how the payoff using the debt avalanche method would differ:
- Credit Card #2 - $4,000 balance, $100 minimum monthly payment, 25 percent interest
- Credit Card #1 - $1,000 balance, $50 monthly payment, 17 percent interest
- Student Loan - $30,000 balance, $350 monthly minimum payment, 5 percent interest
With an extra $200 per month going toward the highest interest debt on top of the minimum payments, the debt will be paid off in four years and 10 months, with close to $6,800 saved in interest.
Deciding between the debt snowball and debt avalanche
There are benefits to both strategies: you’ll save more in interest by going the avalanche route, but don’t discount the snowball method. While small, there is a body of burgeoning research that suggests those who focus on small debts first are more successful in paying off debt long term.
Choosing which method to use comes down to your personality, how much total debt you owe, and how motivated you are to pay it off as quickly (and cheaply) as possible.
To help decide which strategy is for you, look at other goals you’ve tackled in the past.
- Was it helpful to have milestones to hit along the way?
- Do you get tired when working toward a long-term goal?
- Is it more important for you to save money or to be consistent each month?
- What is an ideal timeline for you to become debt-free?
Keep in mind, cutting back and paying off debt can be hard work and you may lose momentum early on without the feel-good effects of a “quick win” under your belt. For this reason, many decide to tackle small balances first in order to truly stick to their pay off goals over time.
While you’re choosing which method is right for you, it’s important to get your interest rates on all balances as low you can (if possible). For those with good credit, now may be the right time to look into debt consolidation or student loan refinancing. This way, when you do choose your ultimate payoff method, you’ll have lower rates and less interest to pay overall as you work to become debt-free.