Living with debt can be a heavy burden, affecting your financial well-being — and peace of mind. In fact, in the second quarter of 2023, household debt in the U.S. rose to a whopping $17.06 trillion, led by credit card balances, according to the Federal Reserve. Fortunately, there are methods to help you tackle debt systematically and regain control of your finances. Two tactics for managing debt are the Debt Snowball and the Debt Avalanche methods. Here, we’ll break down these methods and how they work and help you decide which strategy might be right for your financial situation.
What’s the Debt Snowball method — and how does it work?
The Debt Snowball method is a debt repayment strategy popularized by financial expert Dave Ramsey. The core principle of this method is to start by paying off the smallest debt first and then gradually moving up to the larger ones. Here’s a quick rundown of how it works:
- List your debts: Begin by making a list of all your debts, from the smallest to the largest. This list could include credit card balances, personal loans or other outstanding debts.
- Minimum payments: Continue making minimum payments on all your debts to maintain your credit and avoid penalties.
- Focus on the smallest debt: Allocate any extra funds you have to pay off the smallest debt while continuing to make minimum payments on your other debts.
- Celebrate small wins: Once the smallest debt is paid off, you’ll experience a psychological boost. Celebrate this victory and use the money you were paying toward the smallest debt to add to the minimum payment for the next smallest debt.
- Repeat: Continue this process until you’ve paid off all your debts.
The Debt Snowball method is popular because it provides quick wins, boosting your motivation as you clear each debt. It’s a psychological approach to debt repayment that emphasizes the emotional satisfaction of closing accounts, even if the interest rates on the debts are not necessarily the highest.
What’s the Debt Avalanche method — and how does it work?
Unlike the Snowball method, the Debt Avalanche method prioritizes paying off debts based on their interest rates, starting with the highest-interest debt and working down. Here’s how it works:
- List your debts: Like the Debt Snowball, list all your debts, but this time, order them from the highest interest rate to the lowest.
- Minimum payments: Maintain minimum payments on all debts.
- Focus on high-interest debt: Allocate any additional funds to paying off the debt with the highest interest rate. Continue to do so until it’s completely paid off.
- Roll down the interest rates: Once you’ve paid off the highest-interest debt, move to the next-highest interest-rate debt, applying the freed-up funds from the previous one. Continue this process until you’ve paid off all your debts.
The Debt Avalanche method is financially efficient because it minimizes the overall interest you pay, as you’re targeting the most costly debts first. This method might not offer the same psychological wins as the Debt Snowball, but it can be more cost-effective over the long run.
So, which debt repayment method is right for you?
The choice between the Debt Snowball and the Debt Avalanche method depends on your personal financial situation, goals and preferences. Here’s a handy breakdown of both strategies and who they might be best for:
- Debt Snowball:
- Ideal for individuals who need motivation and quick wins to stay on track.
- Well-suited for those who have several smaller debts that can be paid off relatively quickly.
- Helpful for people looking for a psychological boost as they eliminate debts one by one.
- Debt Avalanche:
- Recommended for those who want to minimize the total interest paid and are willing to focus on the most financially efficient approach.
- Effective for individuals with higher-interest debts, such as credit card balances.
- Appropriate for those who can maintain motivation without the immediate emotional rewards of closing accounts.
In the end, the “right” method is subjective. You can even combine elements of both strategies by paying off a small debt first to gain motivation and then transitioning to the Debt Avalanche method to minimize interest costs. The key is creating a plan that aligns with your financial situation, preferences and goals. Whichever method you choose, the most crucial step is to take action and stick with your plan. Commitment and consistency are the keys to successfully managing and eventually eliminating your debt.
https://www.entrepreneur.com/money-finance/debt-snowball-vs-avalanche-method-choose-the-right/464134