Last week, we discussed building our debt trackers. By now, you should have a track of debt, and be able to review your financial situation for the week. With that in mind, we’re going to look at two methods for paying off debt, Snowball and Avalanche, and their similarities and differences. These two methods provide a foundation for debt elimination that many people use to make progress on the path to being financially independent.
First, we have the snowball method. This approach involves taking your debts, and ordering them from smallest to largest in terms of their dollar values, and paying them off in that order, rolling the payments from the completed debts into the next. The idea behind this method is that the psychological aspects of eliminating smaller debts provides people with enough gratification early on in the process that they will stick with it long enough to pay off their debts.
Alternatively, the other approach is the avalanche method, which orders debts by their interest rates. Like the snowball method, rolling the payments from completed debts into the next debt until all debts are paid off. While this method is less likely to result in paying off some debts quicker, the advantage is that it reduces the amount of interest paid, and the amount you pay overall.
An example of this would be saying you had $1500 per month set aside for paying off three debts: Two Loans (with interest rates) of $10,000 (5%) and $10500 (7%) and a $78,000 (3.65%) mortgage. The snowball method would tell you to concentrate your additional money each month on the $10,000 loan, while the avalanche method would tell you to pay off the $10,500 loan first. The difference between the two methods would be about $129.00 saved in interest. If you’d like to try this out with more simulations, unbury.me has a calculator available where you can plug in all of your debts and see how it works for your personalized situation.