If you’re in debt then you already know how important it can be to improve your finances, but it’s not always easy. Fortunately, there are two ways that you can actually start paying off your debt and get off on the right foot, the debt snowball and the debt avalanche. Each one is great for different types of people, so it’s going to be up to you to figure out which one works best for you. You just need to find out more about what each one is.
The Snowball Method
If you’re looking to pay off your smallest debt before anything else then you’re looking at the debt snowball. With this method, you make payments on that smallest debt until it’s eliminated and then you take that payment and roll it into the payment you’re already making for the next smallest debt. As you continue to pay off debts you start paying more and more on the next one until everything is gone. The big benefit to this method is that you feel like you’re getting somewhere faster because you have debts disappearing.
For a lot of people, the fact that they feel like they’re moving forward and like they’re getting somewhere on their debt is enough to keep them motivated to continue. It might be a little more expensive because you’re not paying attention to interest rates, but if it works then it’s worth the extra cost.
The Snowball Method – Example
Okay, so let’s break down how this process is actually going to work for you, shall we? Once you’ve got all of your bills out and ready you put them in order from smallest to largest. You’re going to make the minimum payment on all of those bills and then any extra money you may have you add to the minimum payment for the smallest bill. Then you work your way up the list, paying the extra on each debt.
Let’s make it a little easier to understand though, shall we? Let’s look at an example of 4 different debts, including one that’s $500, one that’s $400, one that’s $200 and one that’s $100. When you arrange them and start making payments under the debt snowball you’re going to pay the smallest one before any of the rest.
- $100 – $15 minimum payment
- $200 – $20 minimum payment
- $400 – $20 minimum payment
- $500 – $30 minimum payment
What this means is you need to have $85 a month just to make the minimum payments. But let’s say you have $120. You would pay the minimum on the three highest debts (a total of $70), leaving you with $50. You would put that whole $50 to your first debt. When you pay off that debt you take the $50 you were paying to the first debt and apply that (plus the $20 minimum) to the second debt. You would continue to do this until you paid off each debt.
|Getting that first debt out of the way quickly makes you feel more accomplished and helps you to stick with the process.||You’re going to spend a little more time paying off your debts because you’re going to have more interest being tacked on as you go.|
|Getting rid of a small balance quickly means that you have more money to add on to the next debt more quickly.||The interest rates on your debts probably don’t line up with the amount of money you spent on them, which means you’re going to pay more interest.|
The Avalanche Method
With this method of debt payment, you’re actually paying based on the interest rate instead of the balance. You work at the debt with the highest interest rate and pay that one first, then work down the list.
This can be a benefit because when you pay on the debt that has a high-interest rate you’re going to end up paying less over time. Each month you’re going to pay more to the principal and less to the interest, much faster than the debt snowball.
One of the biggest problems and hardest parts of getting yourself out of debt is all that interest that continues to rack up over time. When you get rid of the high interest you’re going to make even bigger progress (even if it doesn’t feel like it). You’re going to actually cut down on the amount of interest you pay and you’re going to actually get out of debt faster this way.
The Avalanche Method – Example
Let’s look at that same debt again: $500, $400, $200, and $100. The first time around you put them in order of smallest to largest, but this time let’s take a look at them in order of highest to lowest interest.
- $400 – 25% interest, $20 minimum payment
- $200 – 20% interest, $20 minimum payment
- $100 – 15% interest, $15 minimum payment
- $500 – 10% interest, $30 minimum payment
If you have a little more to pay on your debts, say $170, you want to apply the money you have in this order. You’re going to start with the minimum payments for the last three debts, a total of $65. But then you’re going to take the $105 you have left and apply all of it to the debt with the highest interest rate, the $400 one with 25%. When you pay off debt one you’ll move down to the second one and add that $105 to the $20 minimum you’re already paying. Keeping going until you get through all of the debt.
|You may have a bit of trouble with motivation because you’re not going to see debts disappearing as quickly as you would with the snowball method.||You’re going to pay off your debt a whole lot faster because you’re paying less in interest the entire way through.|
|You won’t spend as much money on interest.||You’re going to have to dedicate yourself and really get into the internal motivation because you won’t see a change to your debt for a while.|
Which is Better For You?
The best method is going to be the one that works for you, so try to figure out what that’s going to be because both are going to get you debt-free.
For those who are really dedicated to getting themselves out of debt, it’s going to be up to you to choose which method is going to fit your needs. Keep in mind that saving a little more money isn’t going to help if you can’t stick to it, so pick what’s going to keep you going. Does it make you feel more motivated to see your debt disappearing by getting rid of bills or do you want to save money?
If you want to know more about how much you’re actually going to save you can check it out online. There are a whole bunch of calculators that will help you compare the two methods of debt payment and see which will save you the most money and take you the least time. If you use the avalanche method you may be able to actually save thousands of dollars and quite a bit of time in the process of paying off the debt.
On the other hand, for those who don’t have a whole lot of debt or who have trouble sticking to a plan that doesn’t have a lot of visible results, it might be best to go with the snowball. Maybe you want to create your own hybrid plan where you pay off certain types of debt such as credit cards and then car loans and then student loans.
No matter which method you use, it’s going to be important that you stick with it to get your finances back on track. The calculators you can find online will help you figure out what you’re going to have for timeline and for the interest rate.