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When it comes to financial planning, getting out of credit card debt can feel like an uphill journey. If you have been seeking financial advice on debt management, the chances are that you’ve come across several tips, strategies, and methods all claiming to get you back on your feet.
However, these techniques aren’t always reliable and don’t necessarily work. Some experts hail the approach of slow and steady, while others advise you to pay off your smallest debts first.
Some argue that paying off high-interest debt first is the best policy in financial management. But how effective are these strategies? How do you find out which one is the right approach for you?
We believe that paying off high-interest debts first makes the most sense and allows you to manage your finances swiftly in the long run. Let’s discuss in detail below, all the approaches that one can take to tackle debt and why you should prioritize paying off high-interest debt.
Debt Snowball and Debt Avalanche: which approach is more effective?
There are two basic approaches you can take on your overpowering journey to eliminate debt:
- Debt Snowball approach
- Debt avalanche approach
Let’s understand what each of the two entails in greater detail.
Debt Snowball approach
As per the debt snowball approach, you first pay off the minimum amount that is due on all of your debts every month. Afterward, you keep any remaining amount from your budget to pay off your smallest debt.
The concept behind this approach is that when your smallest debts are dealt with, you the confidence to begin tackling the more significant debts.
This approach is based on the belief that quick victories give one the monetary motivation to face bigger battles of debt elimination.
It’s challenging to face debt repayment without worrying, so this approach could give you the wins to build needed motivation to keep going.
Debt Avalanche approach
In the debt avalanche approach, you’ll again first pay off the minimum amount due on all your debts each month. However, instead of using any leftover funds from your budget to pay off your smallest debt, you’ll use this money to pay off your highest-interest debt.
This way, you’ll continue paying the next highest-interest debt after paying off the first one.
Why choose the debt avalanche approach?
By choosing to adopt the debt avalanche approach, you avoid having to pay more money in the long run. If you have a high-interest debt of a more substantial amount and you delay paying it but prioritizing smaller debts first, the charges continue to grow on the highest-interest debt.
This approach saves you from falling into a downward spiral into never-ending debt.
Less interest means quicker repayments
As a person under overwhelming debt, you would prefer to get rid of your debts as quickly and smoothly as possible. The snowball debt approach might sound attractive at first glance, as you’d rather have some debts entirely out of your way.
However, the math doesn’t really add up the best way for you in the long run.
Let’s try to understand the impact with this real-life example. Imagine that you have three debts to your name:
- A $5,000 debt with a minimum payment of $50 per month, and an interest rate of five percent
- Another debt of $10,000 with a minimum monthly payment of $120, and an interest rate of eight percent
- Lastly, you have a debt of $25,000 with a minimum payment of $485 per month and a 10 percent interest
The total sum of your debt becomes $40,000 per month.
For instance, if you budget $800 per month to pay off this debt. After taking care of your minimum payments, it will leave you with a $145 extra amount. Let’s visualize using this amount in both the approaches.
Snowball approach
By using the debt snowball approach, you’ll use the extra $145 to pay off your smallest debt of $5,000. The minimum payment would become $195, and you’ll be able to eliminate that debt in 26 months.
Afterward, you’ll use the $145 and towards your next-smallest debt of $10,000. At this rate, it will take you another 26 months just to bring that amount down to $7,000 ($120 x 25 = $3,000).
Applying $315 ($195 + $120) monthly, you’ll eliminate that debt in 23 months.
At last, you’ll get to the hefty debt of $25,000. By the 40-month, you’ll have paid $18,915 in minimum payments ($485 x 39). As a result, you’ll be left with a balance of $6,085. Applying $800 per month ($485 + $315), it will take you 08 months to eliminate that balance.
Overall, it will take 57 months for you to erase your debt if you choose to use the snowball method.
Avalanche approach
Meanwhile, in the case of opting the avalanche approach, you’ll begin by tackling the highest-interest debt first.
You’ll be paying $630 per month ($145 extra + $485 minimum) on the $25,000 debt. It will take you 40 months to pay the biggest of your debts off.
Later, you’ll use the $630 monthly amount to eradicate the second-highest-interest debt and add it to the minimum payment of $120. By month 40, you’ll have lowered that amount down to $5,320 ($10,000 – $4,680 in minimum payments). With a minimum payment of $750 ($630 + $120), it will take you eight months to get rid of this debt.
Ultimately, you’ll pay down your lowest-interest debt. Your monthly payment will become $800 ($750 rolled over + $50 minimum). At that rate, you’ll be able to pay the $5,000 debt in seven months.
Overall, it will take you 55 months to pay down all your debts using the debt avalanche method. That saves you two extra months of payments while paying less interest, as compared to the snowball approach.
Conclusion
The decision to choose the approach rests on your personal choice ultimately. If you prefer enjoying small victories along the way, then the snowball approach might work in your favor. But, if you’d rather be patient until the final and more economical liberation from your debts, then using the avalanche approach by paying off high-interest debt first is the method to opt for. This is next to the best way to help you erase your debt.
It might take a few years to see the benefits of the avalanche debt approach, but it will be worth the effort.