It’s hard to know where to start when paying down debt. The Avalanche and Snowball methods are two great roadmaps to becoming debt-free.
To illustrate how these two work, let’s say you have 4 debts:
|Loan||Amount owed||Interest rate||Monthly minimum payment|
|Bank of Bellingham (credit card)||$ 10,000||20%||$300|
|Dutch First Credit Union of Lynden (credit card)||$ 2,000||12%||$60|
|Auto loan||$ 6,000||4%||$160|
|Student loan debt||$ 7,500||5.5%||$81|
If you only pay the minimum balances on these loans, it will take you over 10 years to pay them off and you’ll end up paying $7,866 in interest!
Being in debt for the next 10 years isn’t your idea of a good time, so you go through your budget and carve out $200 every month to go towards debt repayment. Following the Snowball method, you put that $200 towards the payment of your smallest loan (amount owed), which is Dutch First Credit Union. This is in addition to the minimum payment you were already making. You will now pay $260 every month until it’s paid off. Once it’s paid off, you take the $260 and add it to the loan payment of your next smallest loan, the auto loan. You’d be paying $160 + $200 = $360. Each time you pay off a loan, you move onto the next smallest, until you are debt-free!
Using this method, you would be debt-free 6 years and 11 months faster and pay $2,330 less in interest.
With the Avalanche method, you prioritize your debt payments based on the interest rate. You take the same $200 from your budget and the first debt you tackle has the highest interest rate, in this case, the Bank of Bellingham credit card (20%). Once you’ve paid off that loan, you move onto the next highest interest rate, Dutch First CU credit card (12%), and so on until you’ve paid off all of your debts.
Using this method, you would be debt-free 7 years and 1 month faster and pay $3,831 less in interest.
You’re probably thinking, “This seems like a no-brainer. If I prioritize my debt payments based on interest rate, I’ll be debt-free 2 months faster and save $1,500+.” And, that’s true. But it’s also true that it will take 2 whole years before you pay off that first debt! Not seeing any landmarks of big progress can be demoralizing. The Snowball method might be longer and more expensive but if it means you pay off your debt, that’s what’s important.