Avalanche vs Snowball methods to pay down your debts; which one is best??
Choosing a method to pay down your debt can be even more important than how much money you have to do it with.
The wrong plan can end up costing you $$ thousands more in interest, take you months or even years longer to achieve debt freedom and could even cause you to fall off the wagon entirely.
Will you go for the snowball debt payment method where you pay off the smallest balance first? Or will you go for the avalanche payment method where you pay off the highest interest one first?
To help you to choose and to demonstrate how these systems work, we have created a very simple case study to show how having the same amount of debt and the same spare cash to pay it off with each month can have vastly different outcomes depending on HOW you decide to go about it.
In this example we are going to look at 3 people; Bob, Sally and Selina who by absolute coincidence have exactly the same amount of debt over the same 2 credit cards and each one of them can spare $500 per month to improve their financial situation.
Bob with savings
Lets start with Bob who has $500 each month to pay his cards and add to his savings so he pays the minimum payment (1.89% of the outstanding balance) off his cards each month and puts the rest of his available cash into an ISA @ 1.5%.
By the end of the year Bob has paid out a total of $6,000, which consisted of $2,781.55 into his credit cards, where he was charged $2,294.52 in interest. He paid $3,218.45 into his ISA which earned him $48.28 and at the end of the year decides to use his ISA and its interest to pay down his cards, this reduces his overall debt by $3,753.76 From $12,300 to $8,546.24.
So the totals for Bob’s 12 months looks like this:
Minimum Payments + Savings =
Sally is in the same situation but instead of putting her spare money into low interest savings, she decides to pay it off her credit cards using the snowball method which means she has decided to throw all her spare money at the Super dooper number 2 card that has a balance of $3,800.
At the end of the year Sally has paid out the same $6,000 but it all went into her credit cards, she was charged $2,112.64 in interest and has reduced her overall debt by $3,887.36 from $12,300 to $8,412.64, almost completely paying off the lower balance card. That’s a $133.60 better than poor Bob for exactly the same outlay.
Snowball Method =
However Selena who is coincidentally in exactly the same situation as Bob and Sally, has decided to pay off her debts with the avalanche method and has started by paying down the Super amazing number 1 card as it has the highest interest rate. By the end of the year Selena has paid $6,000 into her credit cards, she was charged $1,951.56 in interest and has reduced her overall debt by $4,048.44 from $12,300 to $8,251.56. That’s $294.68 better than Bob and $161.08 better than Sally, again for exactly the same outlay and that’s just a single years snapshot!
Avalanche Method =
So, which will you choose? Avalanche or Snowball ??
Imagine for a moment that you have a debt that is higher than $12,300 and that the interest is being charged year after year after year compounding again and again until you pay it off. It’s a hell of a lot of money to pay out just to effectively stand still.
So the cost of inaction is high, you already know that, but look at how amazing it is when you act! This example shows just one year of payments and just a small increase in regular deposits, image that over a longer time span and if you are able to make lifestyle changes in the short term that enable you to pay off lump sums. The results have the potential to be amazing!
Here at Debt Help Tools we’re working on a new tool that you will be able to use to track how lump sum and increased regular payments will affect your overall debt. It will show you the best place to put them for maximum effect and it will re-plot your “date to zero” with every transaction that you add.
Subscribe and download our current free tools now and we will let you know when it’s ready!
Debt Payments & Cashflow
Another point to note here is cash flow.
How we pay down our debts is basically finding a way for the debt to cost us as little as possible. I’m sure none of us would be particularly concerned if we had a pile of 0% debt and the equivalent amount of cash sitting in an investment account safely earning upwards of 5% would we?
So we want to maximise both the cash that we keep and the impact we are able to have on our debt, so in addition to the interest rate assessment that we have just done, we need to look at the minimum payment % too.
If one of your cards has a reasonable low interest rate but they are asking for a high % as a minimum payment amount, that’s really going to have an impact on cash flow, especially if you have only a limited amount to throw at the entire debt on a monthly basis.
The following video explains this really well…..
Ready to see how this might work with your debts?
The first step will be to get organized and take a good look at all your debt on one place.
The simplist was to do this would be with our free debt calculator.
This will enable you to list all your debts, interest rates and assets in a really simple way, it will also work out your debt to asset ratio and show you the loan to value (LTV) rate on your house. If you use this together with the budget calculator, you will be able to work out how much you can use each month towards your debt payments.
Before you move forward with any solution or payment method, be it debt consolidation, a re-mortgage, credit card transfers or anything else, you need to see where you stand and thus be able to evaluate your options accoringly.
As we are continually developing the tools that we offer here, if you do decide to use any of our tools, we’d be really gratefull for your feedback.
Want to get in touch? email us at: firstname.lastname@example.org