‘Snowball’ and ‘Avalanche’ methods explained
The snowball and avalanche methods are a hot topic amongst people in money forums. Simply put, they are methods or strategies a person can follow to pay off their debts.
So, what is the difference between these two strategies?
The Snowball method involves paying off your debts from the smallest amount to the largest amount. Interest rates are not considered using the snowball method. Once you completely pay off the smallest debt, you take what you were paying and add it to your second smallest debt. Once the second smallest debt is paid off, you take what you were paying and put it towards the third smallest. You keep going until you have completely paid off all your debts.
Now the Avalanche method involves paying off your debts from the highest interest rate to the lowest interest rate. Debt amounts are not taken into consideration with this method. When you tackle the debt with the highest rate first, it effectively means you will be paying less interest overall.
Before we get into which strategy is right for you, we need to think through a few things first.
What type of debt are you in?
Have you got multiple credit cards that continue to be maxed out because of random (and fun) shopping trips?
Do any of your large debts carry super high interest rates (above 20%)?
What is your income? Does it allow you to make more than minimum repayments on your debts?
Have you got a budget in place? This must be your first step.
To help you decide which one is best for you, we’ll work through a couple of examples. For the sake of this exercise, imagine you have 4 debts as follows:
Credit card A with a balance of $3,000 at 24% interest
Credit card B with a balance of $1,000 at 18% interest
Car loan of $40,000 at 9% interest
Personal loan of $8,000 at 7% interest
Snowball Example
Remember, this method is smallest to largest amount. List your debts in this order:
Credit card B with $1,000
Credit card A with $3,000
Personal loan of $8,000
Car loan of $40,000
In month 1, you would make minimum repayments on debts 2 through 4. For debt 1 you would pay the minimum repayment plus whatever else you can afford. We’ll pretend you have $400 per month available to throw onto debt 1. Within 3 months you will have paid off debt 1 so you take that $400 per month and add it to the minimum repayment of debt 2 ($65). So in month 4, you take the total of $465 to pay debt 2 until it’s paid off. This will take approximately 7 months. You then take that $465 per month and add it to the minimum repayment of debt 3 ($145). In the eleventh month, you take the total of $610 to pay debt 3 until it’s paid off.
Do you see how the snowball is growing bigger each time? It started out at $400, then $465, then $610.
Avalanche Example
This method is the largest interest rate to the smallest interest rate. List your debts in this order:
Credit card A with an interest rate of 24% ($3000)
Credit card B with an interest rate of 18% ($1000)
Car loan with an interest rate of 9% ($40,000)
Personal loan with an interest rate of 7% ($8,000)
The idea here is to throw everything you can at debt 1 until it is paid off. With a whopping interest rate of 24%, the longer you take to pay this debt off, the more you are paying in interest. In this example, your minimum repayments may not even be covering the interest being charged each month!
Both methods work. Both methods are effective.
Consistency is key.
Some people need to see the quick wins to keep them on track. Seeing the change every month or two can help them to stay motivated. The snowball method is ideal for these people.
For others, it’s important to save the most money (interest being charged) and the quick wins are not as motivating to them. The avalanche would work well for these people.
No matter which option you decide on, it is important to pay more than just the minimum repayment amount. Every pay day, throw whatever you can onto your debt.
I feel we need to caveat something here. If you haven’t changed your money behaviours, there is a chance that you may end back up in debt.
So I have one requisite before I go – if you haven’t got a budget, create one. Having a budget will go a long way to help you staying out of debt.