Debt Snowball Vs Debt Avalanche (With Real Numbers)
We will be talking about the 2 most popular ways to tackle your debt, namely the debt snowball method and the debt avalanche method.
We will talk about how each of these strategies works and the benefits and downsides respectively.
Then we will illustrate the two methods side by side with an example to see which one actually works better with real world numbers.
Then we'll wrap it all up by giving a mixture between the two which provides the best of both worlds, so stick to the end!
Debt Snowball
Alright, first let's start by discussing the debt snowball method.
This approach, popularized by Dave Ramsey, suggests paying off the debt with the lowest balance first, regardless of interest rates.
The idea is to arrange your debts in order from smallest balance to largest balance and focus on paying them off accordingly.
You make minimum payments on all other debts except the smallest one, on that one, you aggressively concentrate all your efforts.
You allocate all available extra money towards it and this continues until the smallest debt is fully paid off.
Once the smallest debt is cleared, you take the minimum payment you were making towards it, along with the extra money, and apply it to the next smallest debt.
This process continues, gaining momentum as you eliminate each debt.
Don’t worry if you don’t understand it, I will plug in some numbers which should make it easier for you to understand later.
As for the pros of the debt snowball method, it would mainly be the psychological benefits. You experience quick progress, compared to the other strategy.
With each debt you paid off, the number of bills reduces, providing further motivation to continue the debt payoff journey. This builds momentum until you ultimately become debt-free.
That’s the theory behind it anyway, but it has been backed up by research.
A study by the Harvard Business Review has shown that individuals using the debt snowball method tend to have a higher likelihood of successfully paying off their debts in full.
However, it is important to acknowledge the downsides of this approach also. Critics argue that the debt snowball method is not the most mathematically efficient way to pay off debt.
By focusing on the smallest balance rather than the highest interest rate, you will end up paying more interest in the long run, especially if larger debts carry higher interest rates.
So what would be the alternative to this?
Debt Avalanche
Well, probably the most mathematically efficient way to pay off debt is the debt avalanche method.
The debt avalanche is similar to the debt snowball, but with a key difference.
Instead of ordering debts from the smallest balance to the largest balance, you prioritize them based on the highest interest rate to the lowest interest rate.
This order determines the sequence in which you pay off your debts.
The primary advantage of the debt avalanche method is its ability to save you money in the long run. By tackling debts with higher interest rates first, you reduce the overall interest you'll pay over time.
With a larger portion of your payments going toward reducing the principal balance, you can clear your debts quicker.
However, it's important to acknowledge the potential downsides of the debt avalanche method. Unlike the debt snowball, the debt avalanche doesn't consider the psychological aspect of paying off your debt.
The motivation that comes from quickly eliminating smaller debts may be absent in this approach.
Additionally, the previous study I mentioned suggests that individuals using the debt snowball method tend to make more progress in paying off their overall debt over the long term.
Example With Numbers
Alright, let's walk through an example to illustrate how the debt snowball and debt avalanche strategies work.
We are gonna follow the journeys of two individuals, Greg and Grace, as they tackle their debts.
Greg’s gonna be using the debt snowball method, while Grace is gonna use the debt avalanche method.
To keep things simple, we'll assume they have identical incomes, taxes, expenses, and debt amounts.
For simplicity, we'll consider three debts:
- a $30,000 credit card balance,
- $20,000 in student loans,
- and a $10,000 car loan.
The interest rates for both individuals are 17% for the credit card, 5% for the student loans, and 3% for the car loan.
The minimum monthly payments for Greg and Grace are as follows:
- $800 for the credit card,
- $350 for the student loans,
- and $200 for the car loan.
We are gonna assume that after deducting their expenses and taxes, they will have $1,000 remaining each month after making the 3 minimum debt payments.
The reason I structured the example this way is to highlight the significant difference between the debt snowball and debt avalanche methods.
By setting the credit card balance as the highest interest rate and largest debt, we can observe the contrasting outcomes between the two strategies.
Greg (Debt Snowball Method)
Okay, let’s start with Greg's debt repayment journey using the debt snowball method.
Greg's initial target is to pay off his $10,000 car loan since it has the lowest balance.
Each month, he makes the minimum payment of $200 on the car loan, along with the minimum payments of $350 on the student loans and $800 on the credit card.
Additionally, he throws all of the remaining $1,000 from his monthly surplus towards the car loan.
By following this strategy, Greg successfully pays off the car loan in nine months.
With the car loan out of the way, Greg's snowball payment increases to $1,200 per month.
Starting from month 10, he directs this increased payment towards his $20,000 student loans, as they now have the lowest balance.
Continuously allocating the snowball payment towards the student loans, Greg manages to completely eliminate them by the end of the 21st month of his debt repayment plan.
At this point, Greg is left with only the credit card debt.
With the elimination of the student loans, Greg's snowball payment rises once again, this time to $1,550 per month from the previous $1,200 per month.
He makes the minimum payment on the credit card and channels the entire snowball payment towards it.
As a result, Greg successfully pays off the credit card in full by the end of the 30th month.
In summary, in two and a half years, Greg successfully pays off his $10,000 car loan, $20,000 student loans, and $30,000 credit card debt by diligently following the debt snowball method.
Grace (Debt Avalanche Method)
But let's shift our focus to Grace and her debt repayment journey using the debt avalanche method.
Just like Greg, Grace has the same debts, income, and expenses. However, she follows a different approach in paying off her debts.
With the debt avalanche, Grace prioritizes paying off the debt with the highest interest rate, regardless of the balance.
In her case, she directs all of her efforts towards eliminating the credit card debt right from the start.
Due to the high interest rate and substantial balance of her credit card debt, it takes Grace quite a while to pay it off.
In fact, she doesn't experience any significant progress until the end of the 20th month, around twice as long as it took Greg.
However, once the credit card debt is fully paid, Grace's snowball payment increases to $1,800 per month since she no longer has to make the $800 minimum payment on the credit card.
This increased payment is then allocated towards her student loan, which has the next highest interest rate at 5%.
Starting from the 21st month of her debt repayment plan, Grace focuses on paying off the student loan and successfully clears it by the end of the 27th month.
At this point, Grace only has the car loan remaining.
With the elimination of the student loan, her snowball payment rises to over $2,150 per month from the previous $1,800 per month.
Grace can now allocate this increased payment, resulting from the $350 she no longer has to pay for her student loans, towards the car loan.
As a result, she pays off the $10,000 car loan relatively quickly.
By the end of the 29th month, Grace becomes debt-free, accomplishing the same debt payoff as Greg but one month quicker.
One significant advantage for Grace is the difference in interest payments between the two methods.
With the debt avalanche, she tackled the highest-interest credit card debt right away, resulting in significantly lower interest payments.
Over her 29 months of debt repayment, Grace pays approximately $6,600 in interest.
In contrast, Greg, following the debt snowball method, accumulated interest payments of over $10,300 over 30 months due to leaving the credit card debt until the end.
Comparing The 2 Methods
When comparing the debt snowball and debt avalanche methods, it becomes pretty clear that the debt avalanche is the faster option for getting out of debt, as long as you remain committed to it.
However, the popularity of the debt snowball stems from the fact that it can be challenging to stick to the debt avalanche when you don't see immediate progress.
Grace, for instance, didn't pay off her first debt until 20 months into her repayment plan, which can feel like a long time without substantial results.
Choosing the right debt repayment strategy for you ultimately depends on understanding your own motivations and how you handle such situations.
What would motivate you more:
- number one, knowing you'll eliminate your debt faster, even if progress isn't immediate, or
- number two, experiencing tangible progress and a reduction in incoming bills, even if it means paying slightly more interest in the long run?
However, as I mention at the start of the article, I would like to present a third option, which is a mix of the 2 methods.
If you have more than 5 types of debt, maybe you have 2 credit cards and 2 different car loans, what I would do is use the debt snowball method at the start, to pay off the debt with the smallest balance first, this is so it gets the ball rolling for you and also reduce the number of debts you need to pay off.
Which is where the psychological factor comes into play.
After that we will switch to the debt avalanche method, where we would start to tackle the debt with the highest interest rate, this is because once we have the momentum going at the start, we can focus on paying off the debt in a way which takes the least amount of time and minimizes the interest that we need to pay.
So what do you think?
Do you agree or disagree with my proposed method?
But if you learn something new or find this debt repayment strategy useful, please do share the article with your family and friends!
Thanks for reading!
P.s. if some of the calculations are a bit confusing, do consider watching the YouTube video linked at the top of the page, which has fancy graphs and visuals.
Which should help you wrap your head around the numbers better :)
- Ivan