So you’ve decided it’s time to pay off your debt. Huzzah! Give yourself a pat on the back.
It’s a bold move and no small undertaking. But if you want to go about it successfully, you’ll need a plan. After all, just tossing cash here and there at random loans or credit cards is a bit like spitting into the wind.
You need a solid strategy.
There are several ways to pay off debt, but these two are the most popular: debt snowball and debt avalanche. Sure, both of them might make you think of a freezing trek through the Alps, but both have their advantages and carry the possibility that you could end up debt free.
Let’s take a look at the pros and cons, and the differences between them, so you can determine which one will work best for you.
What’s the Snowball Method?
With the snowball method, popularized by personal finance author Dave Ramsey, you focus on paying off your smallest debts first while making minimum payments on your larger ones, regardless of the interest rate.
Once you’ve paid off a small debt in full, you move on to the next bigger obligation. Just like a snowball rolling down a hill, each payoff starts off small, and then gets bigger and bigger, gaining momentum.
The Snowball Method in Practice
Say you have $30,000 in student loans at 5.4 percent, $4,000 in credit card debt at 14.8 percent and a $10,000 car loan at 4.4 percent. Under the snowball method, you would make minimum payments on the student and car loans while putting as much cash as possible toward the credit card debt.
Once you’ve paid the credit card debt in full, you would turn to the next bigger debt, the car loan. The idea is that with each small victory, you gain more confidence — and the motivation to stick with the plan and keep paying off debt.
Pros of Using the Snowball Method: It’s Motivational
Researchers at Northwestern’s Kellogg School of Management found that even though the avalanche method makes sense math-wise, the snowball method is more effective overall because it spurs people’s motivation.
Their research showed that paying off a balance — even a small one — has a positive effect on behavior and results in a greater likelihood of a person eliminating his or her overall debt.
“Completing discrete subtasks might motivate consumers to persist in pursuit of a goal,” the researchers said in the study. In other words, people are more likely to stick with it and pay off their debts in total when they’re motivated by small victories.
Pros of Using the Snowball Method: It’s Motivational, Part 2
Personal finance guru Dave Ramsey agrees.
“When you pay off a nagging $52 medical bill or that $122 cell-phone bill from eight months ago, your life is not changed that much mathematically yet. You have, however, begun a process that works, and you have seen it work, and you will keep doing it because you will be fired up about the fact that it works,” he wrote in “The Total Money Makeover.”
He adds: “When you start the debt snowball and in the first few days pay off a couple of little debts, trust me, it lights your fire. I don’t care if you have a master’s degree in psychology; you need quick wins to get fired up.”
Cons of Using the Snowball Method: It’s Dependent on Your Personality
Often, the effectiveness of the snowball method depends on the person.
Keep in mind that the snowball strategy typically takes more time than the avalanche method, which in itself could take an emotional toll. Will the small victories motivate you enough to keep at it for the long haul? It depends on your personality.
Cons of Using the Snowball Method: You Pay More
You’re likely to pay more interest over time with the snowball method since you’re focused on the size of the balance rather than the interest rate.
Because the larger debts are paid off later, you could accrue increasing interest.
Cons of Using the Snowball Method: A False Sense of Accomplishment
Another possible setback is that focusing on the small victories could give you a false sense of accomplishment and sometimes lead to being less likely to face the total debt that’s looming.
In his 2011 study, “Winning the Battle but Losing the War: The Psychology of Debt Management,” University of Michigan professor Scott Rick suggests that people with multiple debts are often motivated to “reduce their total number of outstanding loans, rather than their total debt across loans,” a phenomenon he calls “debt account aversion.”
In other words, people can be encouraged by closing the smaller loans, while simultaneously digging themselves even deeper into their financial hole. So how do you effectively manage the looming total debt? That brings us to the avalanche method.
What’s the Avalanche Method?
The avalanche method is a bit similar to the snowball method, but it’s more mathematical as opposed to emotionally driven. With the debt avalanche method, you focus on paying off the debt with the highest interest rate first — all while making minimum payments on your other loans.
Typically, the math works out better with the avalanche method. You’re able to pay off your debts in a shorter amount of time, and you end up saving more money on interest.
Once the debt with the highest interest is paid off, you turn to the one with the next-highest interest, and so on.
The Avalanche Method in Practice
Let’s go back to the example of having $30,000 in student loans at 5.4 percent, $4,000 in credit card debt at 14.8 percent and a $10,000 car loan at 4.4 percent.
Under the avalanche method, you would pay the minimum amount on your student and car loans, and allocate the extra money each month toward your credit card debt — the one with the highest rate — until it’s eventually paid off in full. Once that’s paid off, you would focus on the debt with the next highest rate.
This method, however, is the most effective when your highest interest rates are on your biggest loans.
Pros of Using the Avalanche Method: It’s Better Mathematically
The avalanche method makes the most sense from a mathematical standpoint. After all, you’re saving more money on interest in the long run.
Josh Patoka, co-founder of No College Debt and founder of MoneyBuffalo.com, used the avalanche method when he was in debt to pay off around $70,000 in loans so that he could change careers and spend more time with his family.
“I didn’t know that’s what it was called at the time,” he said. “But, I naturally choose the lump-sum to monthly payments if I’m given the option, so I think that plays into the picture, too.”
Pros of Using the Avalanche Method: It’s Faster
Chipping away at the debt with the highest interest rate also means you’ll likely get out of debt more quickly than you would with the snowball method. Thanks to using the avalanche method, Patoka was able to pay off his debt in five years, considerably faster than if he had been using the snowball strategy.
“If you take the approach of looking at the total cost instead of only looking at your monthly cost, you’re a lot better off,” he said.
If you’re considering using the avalanche method, be sure to do the math first to figure out the difference you’ll pay in interest. It’s likely to be sizable. So why wouldn’t everyone logically turn to the avalanche method?
Cons of Using the Avalanche Method: It Can Be Emotionally Draining
While the avalanche method will get you out of debt faster than with the snowball plan, it can be hard to stay motivated when you aren’t seeing the small wins. After all, you’re not going to see immediate results, which can be emotionally draining.
If you choose to go the avalanche route, you may need to use a debt calculator to remind you how much interest you’ll pay over time versus the snowball approach. That way, you’ll see exactly how much you’ll save over the long-term and perhaps remain encouraged.
Which Do You Choose?
So which debt reduction strategy should you go with? There’s no right or wrong answer, and a lot of it has to do with what motivates you.
Avalanche might be better from a mathematical standpoint, but when it comes down to it, the best plan is the one that can keep you motivated and that you’ll stick with. Some of us might do better choosing the faster course, but others of us will need the motivational boost of the small victories.
If you’re hard-nosed and don’t have a problem staying motivated, go the avalanche route. But if you find yourself slipping and need a psychological pick-me-up, snowball might be the best choice for you.
Just keep in mind that the best method is whichever one you can stick with.
Stay Cognizant of Your Motivational Level
There’s nothing saying you have to use just one method. You can use a combination of the two. You could start out by chipping away at the smaller, nagging debts, and then shift your focus to the loan with the highest interest rate.
For instance, if you have a fairly low credit card debt with a high interest rate, you could pay that off first, and then use the avalanche method from then on. A hybrid approach is often both psychologically rewarding and more effective.
Or you can try out a different method altogether. Snowball and avalanche aren’t the only options, though they are by far the most commonly used.
Remember: You’re Not Alone
No matter which method you choose, rest assured, you’re not alone.
Whether it’s a looming mortgage, a new car, student loans or credit cards, most of us owe money on something. Americans’ household debt reached a new high in the first quarter of this year, hitting $13.2 trillion, an increase of $63 billion over the previous quarter, according to the New York Fed.
It’s easy to feel ashamed about debt and to be hush-hush about it, but talking about it openly among those you trust can be a key first step towards getting out of it. After all, sometimes the best way to get started is by acknowledging the reality of the situation you’re in. Don’t be afraid to ask for advice from mentors who have struggled with debt and succeeded in getting out of it. Someone who has experience with debt management can help you make a more informed decision.
Better yet, talk about it with a certified financial advisor. That might not be a feasible option for everyone, particularly when you’re struggling with the added burden of debt. But if you can afford it, a financial advisor can you help you map out a strategy that works best for you.