You have three debts, one extra $200 payment and no interest in spending the next five years feeling guilty each and every time you check your bank account. There is a small balance that can be killed rapidly. The other is charging an “ugly” rate of interest. The choice between debt snowball or debt avalanche is either about having to be motivated quicker or about reducing overall debt interest payments.
How the Two Debt Payoff Methods Work
In both cases you will be required to pay the minimum amount on each of your debts. If there is money over and above what you would need to reach one target balance, the surplus is applied to another target balance.
The debt snowball method focuses on repaying the smallest debt. You pay off the $700 debt first, even if it has a lower interest rate than the $3,500 debt and the $9,000 debt.
When the $700 is paid off, the previous payment of that debt will be combined with the current payment on the next debt. The second account will be $200 in additional payment plus $40 minimum payment, which equals $240.
The debt avalanche is different. You pay off the debt that charges the highest interest, first, even if it isn’t the debt with the largest balance. A $4,000 credit card charging 28% comes before a $700 loan charging 10%.
Both methods won’t let you skip out on the other bills. Late payments can lead to late fees and hurt your credit rating.
Why the Debt Snowball Works for Real People
The snowball is generally not the winner in math. It can beat the motivation game.
Assume that you have $800 due on a store card and $8,000 due on a credit card. You have an additional $250 to spend a month. The store card might be off your account in approximately 3 or 4 months, based on their minimum payment as well as interest rate.
That makes you visible and you win a battle.
You have one fewer bill, one fewer due date, and proof that your effort is leading to more results that are satisfying than a slightly smaller number on a statement.
This is important if you’ve already defaulted on debt repayment schemes. If you stop using a spreadsheet after 2 months, it means nothing.
There is no such thing as people being “calculators wearing shoes. If the extra interest is a fair cost to pay, then if you have the momentum to pay off a small account, you should be able to continue going.
Why the Debt Avalanche Saves More Money
Avalanche assaults the debt that needs it the most.
A $5000 credit card with a 29% interest rate will generate approximately $121 in interest charges over the first month. There you will find approximately $33 equivalent to a $5,000 personal loan with an 8% interest rate.
An $88 difference in only the monthly payment on the identical balance.
If you make extra payments to the lower rate loan, the higher rate loan will continue to accumulate interest charges for the longer duration. That’s why, overall, you pay the least interest on this avalanche.
The gap gets even wider as the size of the balance increases. If you make a $15,000 purchase at 28% interest, you will generate approximately $350 in interest in the first month. Some additional minor charges elsewhere will not make up for that.
Don’t just let high interest debt look bad. It charges rent.
What the Difference Looks Like in Dollars
Suppose that you have three debts:
A $1,200 store card at 12%, a $3,800 credit card at 29%, and a $7,500 personal loan at 9%.
The minimum payments on both of your accounts equals $340. Your fixed debt payment is $540, which you can increase by $200 each month.
With the snowball, you pay off the $1,200 balance. You may pay off your first account in about six months. If the interest is calculated monthly based on the standard method, it will take approximately 28 months and interest will be approximately $2,135.
The 29% credit card is the first to go with the avalanche. It would take about 15 months to pay off your first account, but it will wrap up sometime around month 27, and you will owe about $1,918 in interest.
The avalanche saves approximately $217 and completes approximately one month earlier. This snowball provides the first zero balance about 9 months sooner.
So, that’s the whole point of the example. Avalanche safeguards your funds. Snowball safeguards your drive.
Please note that each of these scenarios can change in the event of actual use, such as when interest is calculated every day, minimum payments are adjusted or fees are charged.
When the Snowball Is the Better Choice
Make the snowball when it’s been tough to be consistent, but easier to understand the math.
It also makes sense if your interest rates are near. It may not be that much more expensive to pay off the smallest balance first than to pay off the avalanche, if you owe $600 at 18%, $2,000 at 19%, and $5,000 at 20%.
The decision is reversed when the rate difference is significant. It could seem like you were getting a good deal if you paid $500 at 12% before paying $10,000 at 30%, but the interest on the bigger debt is running around $250 per month.
An average emergency can ruin years of progress with a small emergency fund of $500 or $1,000.
If it wasn’t for that padding, you might find yourself paying $400 for a car repair that gets put right back on the credit card that you just paid off. You will be running as hard as you can without making any progress.
Don’t overlook interest because of the snowball. It’s a vehicle for those who need quick wins desperately enough that those wins keep the plan alive.
When the Avalanche Is the Better Choice
If one account is much higher than others, select the avalanche.
If your debts have interest rates of 7%, 11%, and 27%, you should start working on the 27% one. Each month the loan is outstanding allows the lender to charge costly interest.
As for using numbers for motivation, the avalanche will help. It’s just as rewarding to watch the monthly interest drop from $180 to $120 as it is to close a small account.
Debt consolidation can help when it’s used to replace high interest balances with a truly lower interest loan.
If a person moved the $12,000 from credit cards that have a 27% interest rate to a personal loan that charges a 12% interest rate, the person would save approximately $120 in interest charges for the first month. That’s a difference of $150.
Be aware of the repayment period. A smaller payment made over a five-year period may be more expensive than a larger payment over a three-year period.
You Can Combine the Two Methods
This isn’t a personality test for your whole life!
Using a hybrid solution may be suitable. Pay off 1 very small balance for momentum and then switch to avalanche.
Suppose you owe $400 at 14%, $4,000 at 28%, and $7,000 at 10%. It will only take one or two months to pay off the $400 debt. Thereafter, each additional dollar is used to the 28% card.
The price of that quick detour in maths may be fairly low. The motivational value could be significant.
Establish an “honor system” before starting. It may be best to pay off debts with balances of $750 or less first, then pay off high-rate debts.
Avoid changing strategies every few weeks because of a few lines of a statement. When targets are constantly changing, there is activity without results.
Make the Plan Survive Real Life
Create a simple budget that indicates how much you can afford to pay the debt beforehand.
Don’t offer $600 per month based on one bumper of cash. Consider rent, groceries, utilities, insurance, transportation, and odd bills.
You might find $100 or 250 that could be the amount paid for your debts each month, if you track where that money goes for 30 days.
If possible, set up automatic payments for minimum amounts. Plan the additional payment just after payday; before it gets lost in forgotten purchases, such as eating out or shopping.
Spending $800 on a card and $500 on groceries doesn’t mean that you made a $800 progress. It was closer to $300, before interest.
If you are already struggling with paying out of your budget, the first step to becoming debt free is to make room.
Don’t miss payments, call lenders first. Inquire about hardship programs, reduced rates, fee waiver or deferred payments.
Before aggressive debt payments are made, come housing, food, utilities, insurance and transportation needed for work. It is not discipline to pay an extra $300 towards a credit card if your rent is late. It’s a new problem.
The Bottom Line
The debt avalanche generally pays off the debt at the lowest cost, since it pays off the debt with the highest interest rate first. The debt snowball is likelier to work if you need to see quick results. Pick the method that you can afford to pay each month which doesn’t involve accumulating additional debt. A completed plan is better than a perfect plan that’s never used.
Frequently Asked Questions
Which is better; debt snowball or debt avalanche?
The avalanche is more advantageous in reducing interest. You might find the snowball effect more effective if you have to commit to paying off a small debt rapidly, in order to keep you motivated.
Just how much money can the debt avalanche save?
Saving amounts are based on balances, rates and payments. Also in the above scenario, the avalanche saved approximately $217 on $12,500 of debt but with large high-interest debt, it can be thousands of dollars.
Is it possible to take the debt snowball and turn it into the debt avalanche?
Yes. It’s possible to pay off one little debt to build momentum and then make the highest interest debt payment. Make the minimum payment on them while you’re at it.
Discamiler:
