Debt Reduction: Avalanche or Snowball Method?

Paying off your debts is high on the list of financial priorities. Creating mechanisms to free yourself from the burden of debt can help you get rid of these liabilities, and the avalanche and snowball methods are two popular strategies for doing so.

Both the snowball and avalanche approaches can help you climb out from under your debts, and each has its benefits and disadvantages. Like most personal finance decisions, your chosen path depends as much on the numbers as it does on your individual psychology and preferences. Read on to understand how both methods function and how they can support your efforts to rid yourself from debt.

How Do You Strategically Pay Down Debt?

Making a concerted effort to pay off your loans often requires coming up with a plan of action. While a sudden windfall or major increase in income would be nice, for most individuals repaying their debts relies upon a steady stream of responsible choices.

Increasing the gap between income and expenses is the only tried-and-true method for saving money and reducing debt. It comes down to following a simple equation of either making more or spending less. There is no substitute for creating a budget to help you plan out your expenses, and figuring out where you can remove or decrease certain costs.

The 50-30-20 budgeting method is a popular way to organize your monthly expenses. According to the 50-30-20 rule, 50% of your after-tax income will be devoted for needs, 30% for wants, and 20% for investing, saving, or paying off debts beyond minimum monthly payments. One of the reasons for the popularity of this organizing method is that it recognizes that you need to give yourself room to enjoy life, without completely cutting out your wants and desires.

The basic idea is that allowing yourself room for enjoyment will make it more likely that you will remain committed to the contours of your budget. In a similar fashion, the snowball method recognizes that we must acknowledge the psychological impact of our financial decisions, and not view them solely through the prism of black-and-white numbers.

How Does the Snowball Method Work?

The snowball method of debt repayment has you focus your efforts on your smallest debt, regardless of any other consideration.

In practice, let us say that you have two credit card debts of $10,000 and $2,000, along with a loan from your uncle for $5,000. Using the snowball method, you would devote your efforts to paying down the $2,000 credit card debt. Once you had finished repaying this initial debt, you would then move on to the $5,000 debt you owe your uncle. Only once these initial two debts had been repaid would you begin to tackle the $10,000 credit card debt.

The advantage of the snowball method is that you gradually pick up steam, much like a snowball careening down a snowy hill. You will have the satisfaction of bidding adieu to debts earlier in the process, accumulating wins and motivation along the way. This can be especially important for those individuals who feel overwhelmed by a mountain of debt staring them in the face.

The downside, of course, is that not all debts are created equal, especially high-interest credit card debts which often compound on a daily basis. This is where the avalanche method has merit.

How Does the Avalanche Method Work?

The avalanche method of debt repayment has you focus on paying off the most expensive debt to service first. In this case, you must look at the obligations you owe, and calculate which costs you the most.

Using the above example, let us say that your $10,000 credit card debt charges an interest of 25%, your $2,000 credit card debt has an interest rate of 17.5%, and your uncle is not charging you interest at all on the $5,000 that you owe him. If you decide to use the avalanche method, you would concentrate on paying off the $10,000 debt first because it has the highest interest rate, and then move on to the smaller credit card debt, which has a lower interest rate. Only once these two debts are settled would you begin to pay back your uncle, who charges no interest.

The benefit of the avalanche method is that your overall costs will end up being lower than if you used the snowball approach. The higher the interest rates you are paying, the greater the cost of keeping your debts on the books. For those who are fully motivated and who believe they possess the discipline to remain consistent with their payments, the avalanche method could make the most sense. The downside, however, is that it may take you longer before you are able to rid yourself of your first debt.

While the linear path of the avalanche method is shorter and costs less in the long run, the going can get rough. Longer time horizons lay in store for you, and it does not bring you the positive psychological impact of getting rid of one of your debts quickly. That being said, everyone has their own set of preferences and profiles. You need to think about what would work best for you.

Conclusion: Is it Better to Snowball or Avalanche?

From a pure financial standpoint, the avalanche method is the optimal way towards debt repayment. However, the most important factor to consider is which method will be easiest for you to remain committed to.

In a perfect world, your smallest debt would be the one with the highest interest rate, allowing you to combine these two methods and enjoy the best of both worlds. Life is not always so convenient, however, so you are forced to choose.

Another wrinkle to consider is the emotional cost of the loans. For example, if your uncle is giving you a hard time–making a previously enjoyable relationship somewhat strained–it might be worth giving that obligation a higher priority even if the financial cost is minimal.

Combining your debts is another possibility, whereby you would find another lender who would consolidate all your loans into one larger obligation. Some individuals might even find luck refinancing into a loan with a cheaper interest rate, though this is not a given.

Ultimately, the most important consideration when making a debt repayment plan is finding one that you can feel comfortable sticking with. Whether it is snowball, avalanche, or even consolidating all your debts into one, make sure that you are picking the path that fits both your financial and psychological needs.

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