I’ve been thinking a lot about these two topics lately; partially because they have been mentioned briefly on television during self-help segments, and partially because it is so very hot and humid in my hometown right now, the thought of snow is enticing!
You have heard the terms “debt snowball” and “debt avalanche” when reading personal finance and debt repayment articles, but do you know what these terms really mean? How will using one of these methods help you reach freedom from debt?
Lucky for you, I’ve got the quick and dirty on both methods below. First step before we begin is for you to collect all the information you have on your debts. If you have student loans, nslds.ed.gov can provide you with a list of your federal student loan debt information (including current balance totals!).
Second step, check out your budget to see if you can free up any money. Do you buy four lattes a week? I’ve already admitted to my Dunkin Donuts weakness, so I completely understand. But can you possibly cut down to two lattes a week, and home-brewed coffee the other days? Cuts in your budget like this will help you build your monthly “Extra Money” fund, which we will throw at your debt with a vengeance!
Using the snowball method, you would place your debts in order from smallest amount you owe to the largest. The first debt targeted for payoff will be the smallest total debt amount due, not which has the lowest minimum payment due. Interest rates are important to know (as always) but have nothing to do with determining the order in which your debts are paid off.
Make a list using the following categories:
- Debt Name/Lender
- Total Amount Due
- Interest Rate
- Monthly Minimum Payment
- New Payment
You can either do your list on blank paper of Microsoft Excel. I personally like handwriting it because then I feel more in control of the formatting.
Next, look at your loan list and find the loan that has the lowest total amount due. (Do not order them by monthly minimums to be paid!) This will be the first debt written on your Snowball list. Make sure to include all of the debt’s information in the other columns. Once that’s done, go back to your debt list and find the next smallest total due. That will be your second loan in your snowball. Continue down your list until you have ordered all of your debts from smallest to largest total due.
Remember that extra money I talked about earlier? Here’s where it comes into play. Add that extra money to the minimum payment for debt #1 on your snowball list. This is your new monthly payment (put this total into the “new payment” category). Pay this much each month until the debt is eliminated! For the time being, pay the minimums necessary on the rest of your loans.
Then, you will take that amount (minimum payment of debt #1 + extra money) and add it to the minimum payment of debt #2. This is now your new payment each month for debt #2.
Continue this until you are free and clear from your debts!
Pros: You will be able to see progress more quickly, giving you more motivation to stay on track.
Cons: This method will take longer as you will be paying more interest on the larger amount debts, and in the end may cost you more by the time you are completely debt free.
You will be able to see progress more quickly, giving you more motivation to stay on track.
The debt avalanche is pretty similar to the snowball, with one minor caveat: it’s ordered differently. The method, besides that, is basically the same.
For the avalanche, you will take those debt and, in your beautifully written or typed Excel spreadsheet, order them from highest interest rate to lowest. Yep, it seems a little strange, but ordering your debts by their interest rate alone will actually give you a quicker payoff period (as long as you go from highest rate to lowest).
Simply put your debts in your avalanche list as I detailed above for the snowball, with this one little change. Total amounts due don’t matter here, unless you have two interest rates that are the same. (In that case, the higher total amount would be placed first.)
Once you have your list, add the extra money just as you would for the snowball: one debt at a time. Pay the minimums on the rest. Before you know it, your debt will be shrinking!
Pros: Your debt will be paid off faster, with less paid over the life of the loan because you are knocking the higher interest ones out fast! (There’s a reason they call it an avalanche!)
Cons: It may take longer to see results from the avalanche than you would with a snowball. That is because you are paying off a theoretically bigger loan first, and that will take a bit longer. This might kill your motivation if you aren’t prepared for it.
Personally, I plan on trying the avalanche method for debt repayment. I’m still organizing my files and debts, but once I do, I’ll share with you guys!
Has anyone tried either of these methods in their debt repayment? What obstacles did you run into (or jump over)?