What’s the best strategy to implement to pay off your debt? Paying off debt can be a long, tedious, and sometimes confusing process. In order to simplify the process and make steady progress each and every month, you need to commit to a strategy.
When deciding on a strategy, it’s also important to understand that your priorities and situation may be different from the next person, so what works for someone else might not work for you. If you’re eager to pay off your debt in the most efficient way, there are two main debt repayment strategies you should consider using – the debt snowball vs. debt avalanche methods.
1. The Debt Snowball Method
The debt snowball method involves focusing on paying off your smallest debt first, then rolling that payment amount onto the next smallest debt when you’re ready. This strategy focuses on small wins, staying motivated and building momentum with your debt.
For example, if you have $2,000 in credit card debt, a $5,000 personal loan, and a $10,000 auto loan, you would start paying off your credit card debt first. Let’s say you’re able to put $400 on your credit card debt each month and pay it off in five months. Then, you manage to add an extra $100 and start putting $500 on your personal loan and pay the minimum on your auto loan for the time being. You keep repeating the cycle until all of your debt is paid off. By the time you get to the largest balance, you’ll already have two accounts paid off which will provide a great motivational boost.
If you tend to lose motivation during the middle of a goal, don’t panic, as this isn’t uncommon. It’s not easy to contribute lots of your hard earned money to paying off debt each month and if you don’t see your balances decreasing, you could start to lose motivation. The debt snowball method works because it allows you to see progress quicker and grow your payments overtime to get rid of your debt.
2. The Avalanche Method
This strategy for debt repayment focuses on paying the least amount of interest over time which ultimately saves you money. With the avalanche method, instead of focusing on which balance is lowest, you focus on the debt that is costing you the most money first.
Interest is accrued to your debt on a daily basis. Therefore, the quicker you eliminate it, the more you can save over time.
As an example, let’s say you have $2,000 of credit card debt at a 0% interest rate currently (until December 2016), a $13,000 car loan with a 10% interest rate, and $25,000 in student loans at a 5% interest rate.
Right now, it looks like your biggest problem is your car loan. While it may seem like a good idea to knock out your credit card debt, it really isn’t costing you any extra money in interest so it’s not a priority when using this method of debt repayment. You should also consider calculating how much interest your student loans are costing you each month. Even though the rate is often lower than other forms of debt, if the balance is high, it could make a big difference.
It’s also important to note what your interest rate will be on your credit card once the 0% introductory rate is up. If that rate is going to jump to 25%, it could be smart to pay that off first and then worry about the car debt.
Can These Two Methods Be Used Together?
Of course. Sometimes your debt situation may not be so black and white. Your lowest balance can have the highest interest rate, which would allow you to utilize both strategies of debt repayment.
You may start out using the avalanche method, then start losing your focus or falling for spending temptations, which may prompt you to switch to the snowball method so you can start to make some progress again and restore your momentum.
Which Method of Debt Repayment is Best for Me?
As long as you’re paying off debt and making progress, there is no right or wrong method or strategy. If you have specific intentions though, you may find one of these strategies to be more beneficial than the other.
If you are eager to pay off your debt so you can tackle other goals or if you have a large amount of debt that you are determined to pay back, you may consider the avalanche method if you can’t stand seeing interest pile up. The avalanche method will not only help you pay off debt faster and more aggressively, but it can help you save thousands of dollars on your debt throughout your repayment term.
On the other hand, if your debt repayment journey looks like it will take a little longer and you have a smaller amount of money to put toward your debt each month, you may favor the snowball method. If you have other priorities within your budget, the snowball method will help you still feel a sense of accomplishment while paying off your debt. While you’ll probably pay more interest over the life of your debt with this method, you’ll still pay off your debt quicker than you would have with absolutely no strategy and it’s a great way to fight off debt fatigue after you’ve been making payments for several months or years.