The decision to focus your energy on paying off your debt is an incredible step in taking control of your finances. Once you’ve knocked out high-interest debt in particular, you’ll free up your money to then hit even greater goals for things like a down payment on a home, retirement savings, or a vacation.
To be really strategic with the funds you have available for paying down debt, consider choosing between two popular methods: the debt avalanche or the snowball effect. Not sure what those two strategies entail? Keep reading to find out what they mean and which is better for you.
What Is a Debt Avalanche?
The debt avalanche method has you prioritize your debts by interest rate. You’ll need to start by finding out all your current APRs across the accounts you want to pay off, including credit cards, loans, and lines of credit. Once you’ve identified the balance with the highest rate, you’ll funnel all your extra debt payments to that account. You’ll still need to make the minimum payments on all your other debt. Any money you can divert to extra payments, however, should be focused on that first balance with the highest interest. Once you knock that one out, you’ll then move on to the debt with the next highest rate.
The single greatest advantage to the debt avalanche strategy is that it saves you the most money in the long run. Because you’re tackling the highest interest rate, you’ll stop paying that APR sooner, regardless of what your balance is. That means you’ll start accruing less debt from a growing principal balance thanks to those high rates.
Sometimes the choice might be as obvious as a credit card with an 18 percent APR versus a car payment with a 6 percent APR. Clearly, you’ll save more money if you can get rid of that 18 percent rate faster. If you have multiple credit cards or high-interest personal loans, you may need to do some digging as to which one will save you more over time.
While it makes sense to pay down your biggest APR debt from a financial perspective, it might not be the best move from a morale perspective. It can take longer to get a win depending on how high your balance is from the start. Still, if you can stay motivated, you could end up saving a lot more money throughout your entire debt payoff process.
What Is the Snowball Effect?
There are a few key differences when considering a debt avalanche versus the snowball effect for your payoff strategy. The snowball effect has you start by paying off your smallest debt, regardless of how much the interest rate may be. After you pay down that balance, you then move to the next smallest balance.
In the meantime, you’re still paying minimum balances on all your other accounts. As you pay and focus on lower-dollar balances, you gain momentum and confidence in your ability to knock out your debt altogether.
The debt snowball effect has the power to keep you motivated to continue making progress. When comparing the debt avalanche versus the snowball effect, you might automatically assume that the best option is the first one, since you have the potential to save more in the long term. But if you lose momentum and instead give up on your debt payoff goals, you’re not doing yourself any financial favors.
Instead, give yourself the easy win with the debt snowball. Once you get the ball rolling, you’ll be inspired to keep funneling your extra dollars to paying off debt. One small victory leads to a larger victory until you’ve ultimately knocked out your debt completely.
The obvious disadvantage to the snowball effect compared to the debt avalanche is that you could potentially end up paying more cash in interest over time. If your smallest balance happens to have a low-interest rate, you’ll have more months where you’re paying on those higher rate accounts.
You really have to weigh the pros and cons of what motivates you more: saving money or having the stamina to keep making those extra payments each month. It’s an extremely personal decision and, ultimately, there’s no right or wrong answer.
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