In the world of debt reduction, two methods vie for supremacy; the debt avalanche and the debt snowball.
Debt snowballing tells you to pay off debts from the smallest amount owed to the highest amount owed, while the debt avalanche strategy involves paying debts with the highest interest rates first, then moving to your lower interest rate debts.
Imagine you’re a firefighter
I found a great analogy for the two systems from ReadyForZero that goes like this:
Imagine you’re a firefighter and you’re called to save a burning house. You enter the house, and see two main areas of fire: two burning logs in one corner, and five burning fuel tanks in another. The logs are bad, but the fuel tanks are wreaking havoc. Which do you put out first?
Most people’s gut reaction is obvious: put out the tanks. Those things are going to blow up.
However, if these two groups of burning objects were your debts, the snowball method would tell you to put out the logs first, because there are fewer of them. Then, after an early victory, you move on to the fuel tanks.
The avalanche method would tell you to put out the fuel tanks first, because they are more flammable and spreading fire faster. Here’s the reality: Your high interest debts are like those fuel tanks, burning down your financial house. Due to compound interest, they cause much more damage than low interest debt, no matter what size the debts are.
A Side by Side Comparison
Let’s use these debts as an example:
American Express: $3,000 owed, 14.99% interest
Student Loan: $10,000 owed, 4% interest
Visa: $12,000, 25.99% interest
Here we will assume you can pay $1,000 a month paying off debt. This is what it would look like using the Snowball method:
You would be out of debt by July 2015 and you’ll pay a total $7,779.11 in interest.
And here’s the same debt payed off with the Avalanche:
With the avalanche method, you’ll pay off the same debt two months earlier and pay $6,129.36 in interest, a savings of $1,649.75.
The Bottom Line
The decision about which method to use really comes down to head vs. heart, math vs. psychology. There’s no question that you will pay off debt more quickly (and consequently pay less interest) by Avalanching your debts. If you are the type of person who can stick faithfully to a plan with no extra motivation needed, go with the Avalanche.
For many of you, debt reduction is a psychological war. In order to keep morale high, you’ll need to win several small victories along the way to conquering all your debt. If this describes you, start Snowballing today!
Check out unbury.me to plug in your own numbers and see which method will work best for your financial situation.