So, you’re tired of being in debt and you are ready to put together a debt elimination plan. Awesome!
You may have heard of the debt snowball and it’s similar, yet different, partner the debt avalanche.
These two methods are almost exactly alike in that they both ask you to pay minimum payments on all your debts except for one focus debt.
With either method, you’ll send every extra dollar you can find until the focus debt is paid off. Once it is, then the next debt in line becomes you new focus debt. As you pay off your debts and your minimum payments go away, you will have more and more money to send as additional payments to the debt on which you are focused (hence the snowball analogy).
The only difference between the snowball and avalanche is the order that you will pay off your debts. Some personal finance writers zealously argue that one is better than another; we believe it’s a matter of personal preference (as long as your debt is going down!)
What’s Ahead:
The debt snowball method
With the debt snowball method, you pay off your debts from smallest balance to largest balance, regardless of interest rates.
The reason for this is that often times people have a lot of little debts lying around. Lots of statements coming every month. Lots of minimum payments to pay and it gets overwhelming. Doctor’s bills from several different places, little balances here and there on store credit cards, or money borrowed from family members.
It all just feels overwhelming when it seems like everywhere you turn you owe more money.
When you pay your debts from the smallest to largest balance you start to clear those little debts away very quickly. Depending on your situation you might even get rid of an entire debt every month for the first few months.
That feels very empowering. You see progress quickly and you start to feel like you really can do this. Then by the time you start tackling the larger debts, like your car loan or the big credit card balance, you have the confidence, ability, and extra cash flow to make it to the end.
The debt avalanche method
In the debt avalanche method, you pay your debts from highest interest rate to lowest interest rate, regardless of balance.
Mathematically this makes the most sense. You will pay less in interest if you tackle your debts in this order. Saving money on interest means you will pay your debts off more quickly. Isn’t the whole point of getting out of debt to do it as quickly as possible?
You get the most bang for your buck when you tackle the highest interest rate first. Why pay a debt that isn’t charging any interest when you have a credit card that is charging 18 percent?
The secret no one is talking about
Some people have zealous opinions about which method is better. The Dave Ramsey crowd is hell bent on the debt snowball—it has a cult-like following. The avalanche group thinks math rules over all and can’t understand why everyone doesn’t see it their way.
But here’s the secret… it barely matters!
The best way to pay off debt is to make the minimum payments on all of your debts except one focus debt. Hone in on one debt and send every dollar you can towards that debt until it’s gone. Which debt you pick makes very little difference! Don’t believe me? Let’s do the math.
Let’s take a husband and wife, Joe and Suzie, with the following debts:
Together they have decided they can pay $1,000 a month towards debt payments, including all minimum payments. Joe wants to pay off their debts using the avalanche method, highest interest rate first. But Suzie wants to use the debt snowball and pay the lowest balance first.
- Using Joe’s avalanche the couple will be debt free after five years and four months. They will pay $8,394 in interest.
- Using Suzie’s snowball the couple will be debt free after five years and five months. They will pay $9,378 in interest.
The difference is one month and $985 over five years.
Now, $985 is a good chunk of money. But by month, there’s only a $15.15 difference in interest doing it the snowball way vs. the avalanche. The point is, it’s not worth fighting over. I say, pick the debt that bothers you the most and tackle it. Then move on to the next debt that is bothering you the most and so on.
Summary
The snowball and avalanche methods are nearly identical in that you’ll be able to pay off your debt quickly (depending on how much debt you have). Staying motivated is more important than a few extra dollars in interest that you’ll save through the avalanche method. Because the worst result is giving up on you plan or sliding back into debt.
Want to check it out with your own numbers? You can download a debt snowball calculator here that will allow you to compare the snowball, avalanche, and a custom order.
Article comments
A combination of both may work better for some as well. I have a few small debts with low interest rates but why not knock them out in 2 or 3 months to remove that minimum payment, and then focus on the debts that are charging me the most in interest. I don’t think the avalanche effect takes into consideration that the highest interest rate may not be the one charging you the most interest. If I have a $3,000 debt at 20% interest, and $5,000 debt at 15% interest, I am actually being charged more interest on the $5,000 even though the interest rate is lower. It makes more sense to me to focus on the debt costing me the most. Excel is a great way to compare what methods would work best for your individual situation.
In addition to the psychological aspect, which is huge to some people, the amount of the minimum payment is a big factor, too. I had a medical debt that had no interest, but the minimum payment was $100 a month. The principal at the time I started snowballing was about 1000.
Conversely, a high-interest credit card with a balance of 7000 had a minimum payment of about 100 also. The factors here are not just interest rates. If the smaller loan with no interest is out of the way, that frees up $100 a month to go toward the higher interest after a short period of time. Waiting for the higher interest loan to be paid first postpones a more efficient use of that first $100 a month.
Minimum payments on high interest credit card debt are often very small in relation to the principal, it’s part of debt-farming on the part of the credit card company. But in addition to giving you a psychological boost, paying the smaller balance first can also give you quicker access to better use of a relatively large minimum payment.
“it barely matters!”
Well, unless your largest debts happen to have the largest interest rates. Taking your data table as-is, except with the highest interest rates on the largest debts, I get a $4427 difference. So might be worth saying that it barely matters in most cases, but it is probably worth examining your particular scenario before starting.
Interesting article overall. I used to believe firmly in using the debt avalanche method for debt elimination, however, I discovered by running some number that it does not always work out to be the fastest or even barely different in all cases. The rate of interest is a factor but the outstanding balance, minimum payment amounts, and the time needed to pay off each debt all affect the outcome. It turns out to be a time-varying problem. In my personal situation, I just had a student loan and a home mortgage where the student loan ($6000 remaining with minimum payment of $120 a month) had an interest rate of 2% and the mortgage ($85,000 balance with minimum payment of $590 a month) at the time had an interest rate of 6%. In that particular case, it was actually years faster to pay off the student loan first rather than paying extra on the mortgage and letting the student loan ride for the full 10 year repayment term, which was my original plan. However, I agree with the overall conclusion of the article that getting out of debt and in control of finances has a lot more to do with motivation and behaviors than understanding the math.
Great article. I’m 30 so just in the nick of time! (re:website target audience)
I’ve been lucky I never had to utilize either method but I was intrigued with these methods. I created a calculator on my own blog that works out the exact numbers. There is no doubt that the majority of the time Avalanche is cheaper.
That said, snowball is around for a reason. Depending on the kind of debt you have the price of Snowball can be higher than would make sense but, in some cases the price you pay for the snowball method (almost always is more expensive) may be worth the psychological boost
What you have to figure out is how much the boost is worth to you.
I agree with you saying that it may be worth the psychological boost when the snowball method is used. People feel better when there is instant gratification and that they are really accomplishing their goals.
My personally know that the Avalanche is better off in the long run due to paying less in interest. My psychological feeling is not about paying off the little ones first. I want to tackle the bigger debt (focus debt) knowing I can accomplish that and pay companies Less in the long run.
Have to agree with the author; in the end, whatever keeps you motivated and on track to getting rid of your debts is the best path. The psychological effect of eliminating a credit card balance is worth something.
It’s like exercise. The best workout is the one you’ll actually do. There’s almost certainly a more effective exercise routine, but that doesn’t matter if you can’t be motivated to do it…
I fail to see how $985 “isn’t a huge difference”. To me, that’s $985 less I have to give to those crooks I call student loan holders (*cough* NELNET *cough*). Might be the math nerd in me, but paying less money seems pretty logical to me in the long run, especially focusing on that rule “spend less than you earn”.
It’s not, in the grand scheme of things. The point of the exercise is to get out of debt as quickly as possible. Using the highest rate method first you might save yourself that $985 but the Nelnet loan would be the last to be tackled, so you’d still end up paying them more in interest anyway, thereby defeating your primary goal of thwarting what you refer to as “crooks,” (though presumably you entered into a loan agreement with them voluntarily). Using the snowball method, Nelnet would still be tackled last, but at 4%, and only one additional month of payments, Nelnet wouldn’t have been the creditor who got that extra money anyway. Hope this helps you see the problem with thinking with emotions instead of logic.
And your example isn’t mathematically sound,
How is that not sound? You pay less money to people that you owe money to. You’re assuming my interest rate on student loans is the lowest, but in reality, it’s the highest (definitely not 4%). Some of us graduate at different times, and interest rates vary based on many factors.
Another point, I did not voluntarily enter into an agreement with them. They bought my loans from the DOE 6 months after graduation (a very convenient time for them). Nothing in this explanation is emotional, although I really have a dislike for that company (as do thousands of other loan holders).
Not knowing the details, I could see how your retort would make sense. Nelnet is widely known for its attempts to get more money. Still not sure why a financial blog would say $1000 is not worth your time, when most advocate for saving petty amounts in the name of financial progress.