November 21, 2017

The Debt Avalance vs the Debt Snowball…which is better?

Jordan Linville

In Debt ReductionAdvertiser Disclosure

Four years ago, popular personal finance guru Dave Ramsey popularized the concept of the “Debt Snowball.”  His recommendation was simple – rather than pay down the debt with the higher interest rate first, pay down the smallest debt first regardless of the interest.  The idea is that you’ll give yourself some small wins in reducing debt and simplifying your life, and this momentum will carry you into further success in paying down larger debt amounts.

Once this Debt Snowball term caught on, the traditional method of paying down debt – where you pay down the highest interest rate debt first – was dubbed the “Debt Avalanche.”  The Debt Avalanche makes sense financially because you are paying down the highest interest debt first, which is to say the most expensive, and you will be saving more money than if you paid down less expensive debt with the same amount.

So in summary, the two definitions are:

1. The Debt Avalanche – paying down the highest interest rate debt first and then moving on to lower interest rate debt.
2. The Debt Snowball – paying down the lowest total amount debt first and then moving on to larger debt amounts, regardless of the interest rates on each.

OK, so which one is best?

First, in both methods, you should pay the minimum payments on all debts before you do anything.  That’s important because not paying the minimum means that you are going to incur fees, and that is just throwing money down the drain.  Second, paying down debt in ANY WAY POSSIBLE is good.  So if you’re paying anything, it’s a good thing.

The decision depends on how disciplined you are.  Mathematically, the Debt Avalanche clearly saves money in the long-run.  Over two years, if you paid the exact same amount per month towards your highest interest rate debt first, you’d save money as compared to paying down your smallest debts with lower interest rates first.  That’s a fact.  HOWEVER, many people with debt problems lack the financial discipline to support this purely mathematical argument behind the Debt Avalanche method.  Money is emotional.  We need psychological tips and tricks to change our mindset and how we relate to money.

For this reason, generally speaking, BrightRates advocates the Debt Snowball method.

There’s a reason that so many people have used the Debt Snowball method successfully – it works!  Have you ever kept a To Do list?  What happens when you check off an item from a To Do list?  It feels the great.  Your brain releases a tiny shot of dopamine which is the same drug released when a person wins in gambling.  Crossing a debt account off your list is powerful.  It builds financial discipline, breeds confidence, and begins a routine.  Once you’ve paid off a small account or two, does it make sense to concentrate on the highest interest account?  Probably.  But only if you feel confident that you will stick with your plan.

Does the math support our viewpoint?  No.  We’ve already acknowledged that.  But if this were a mathematical decision, no one would have debt to begin with.  The psychology of the typically borrower with debt supports our viewpoint – and so does the academic research.  In “To Beat Debt, Consider Starting Small,” Kellogg School of Management professor, David Gal, writes that people who focus on closing small accounts first will ultimately be more motivated and payoff more debt in the long-term.  The Harvard Business Review also supports this point-of-view in Remi Trudel’s article, “The Best Strategy for Paying Off Credit Card Debt.”

Again, money is personal and that includes how you pay down debt.  But if you find yourself struggling with making payments on debt, we recommend paying down a couple of the smaller accounts first.  It will give you the small wins you need on a road to conquering your debt.

See if you qualify for a low-interest consolidation loan.