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I have not paid any interest on debt for several years, outside of my mortgage. That is because I have not had any debt for several years. But this wasn’t always the case.
I, like many Americans, struggled with debt for many, manyyears. I never really dealt with it even though it always bugged me. Mystrategy was always to just make payments and always strive to earn more moneyas my career progressed.
I never really had a plan to pay my debt off. I was justfocused on ways to live with it.
The problem with a half-hearted plan such as this is you never really deal with the debt. When I would get those end-of-year statements showing how much interest I was paying, it was clear I was wasting a lot of money.
I needed a real strategy, not just a way to cope.
What I Finally Did
I employed a specific strategy that worked for me. After I had paid off my debt I found out that this strategy actually has a name: The Snowball Strategy.
Two Different Strategies to Paying Down Debt
There are two prominent strategies for paying down debt. Tome they have one significant characteristic that separates them and determinedwhy one worked for me better than the other. I suspect that this characteristicmay determine which one works better for you as well.
What is this difference? One of these strategies is rational and one is emotional.
The Snowball method is the emotional approach while the Avalanche method is the rational approach. Surprisingly enough, while I consider myself more on the logical/rational side in most respects, when it came time to pay off debt, I really needed the emotional approach.
Snowball Method – The Emotional Approach
The snowball method of paying off debt is when you do thefollowing:
- Make minimum payments on all of your debts.
- Then take any extra money you have left over and pay it towards the smallest debt.
- Once that small debt is paid off, you then take the extra money and the monthly payment from the smallest debt and put all of that towards the next smallest debt.
This will hopefully result in paying off the smallest debt rather quickly which will, in turn, give you an early victory and a feeling of accomplishment. It is this quick feeling of accomplishment and the resulting momentum that gave me the motivation to keep paying down my debt. And trust me, I needed that momentum.
It wasn’t until after I paid off my debt that I discoveredthis is an established method that was originally proposed by financial guruDave Ramsey and later espoused by Robert Kiyosaki.
Avalanche Method – The Rational Approach
The avalanche method of paying of debt also requires you tomake minimum payments on all of your debt. How this strategy differs is in howyou apply any extra money you have.
With the avalanche method, you would take any extra money you have and plow it into payments on the debt with the highest interest rate, not necessarily the debt with the smallest balance. Why would you do this? Because the highest interest rate is costing you the most money in the long run. By paying off your debt with the highest interest and then progressing towards the debt with the lowest interest rate, you should be paying the least amount of money overall.
What the Numbers Look Like – Avalanche Method
Here are some hypothetical numbers for us to look at.
- Credit Card A: $8,000, 18% APR, $180 monthlypayment
- Credit Card B: $4,000, 15% APR, $85 monthlypayment
- Car Loan: $10,000, 6% APR, $420 monthly payment
- Student Loan: $20,000, 8% APR, $145 monthlypayment
The total monthly payments in this example are $820. Supposeyou have $1,100 per month to pay towards your debts. This would mean that aftermaking your minimum payments you would have $280 left over. With the Avalanchemethod you would put that extra $280 towards paying down Credit Card A, sinceit has the highest interest. Then you’d move on to credit card B then thestudent loan and finally the car payment.
The order of payoff under the Avalanche method would looklike this.
- Credit Card A: $8,000, 18% APR, $180 monthly payment
- Credit Card B: $4,000, 15% APR, $85 monthly payment
- Student Loan: $20,000, 8% APR, $145 monthly payment
- Car Loan: $10,000, 6% APR, $420 monthly payment
What the Numbers Look Like – Snowball Method
If we were following the snowball method our order of priority would be different.
- Credit Card B: $4,000, 15% APR, $85 monthly payment
- Credit Card A: $8,000, 18% APR, $180 monthly payment
- Car Loan: $10,000, 6% APR, $420 monthly payment
- Student Loan: $20,000, 8% APR, $145 monthly payment
With the Snowball Method you would also make minimumpayments on each debt, but you would put that extra $280 towards paying offCredit Card B since it has the smallest balance. Adding $280 to the $85 minimumpayment would definitely accelerate your progress towards paying off the $4,000balance quickly.
The Research
Once I decided to write this article, I discovered there isresearch out there conducted by the Kellogg School of Management, HarvardBusiness Review and others. Their research supports the snowball method. Thefindings state that if you focus on paying one bill off at a time and focus onthe smallest debt first, most people will have a better chance of success.
According to the Harvard Business Review (December 27, 2016) “Ourresearchsuggests that people are more motivated to get out ofdebt not only by concentrating on one account but also by beginning with thesmallest.”
Conclusion
Despite all of the above, you should try to determine which methodwill work best for you. Look closely at your numbers and honestly assess whatthe financial cost will be in interest as well as assessing your own level ofdetermination. Perhaps the Avalanche method will work better for you, resultingin less interest paid. Or perhaps the Snowball method works best for you,providing you with early victories and a boost to your motivation.
Either way, I wish you luck.
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