There are many Americans who have found themselves stranded atop a mountain of debt. For those determined to navigate down the mountain the first question is, “Where do I start?” If you have multiple debts of various sizes and interest rates, it can be difficult to decide which debt to pay off first. Here are two ways to come down from a mountain of debt, aptly coined the Avalanche method and the Snowball method.
The Avalanche Method
The Avalanche method is the preferred method to minimize the total cost of paying down debt. This method looks at interest rates only. To pay down debt using this method, you focus on paying down the debt with the highest interest rate first, no matter the size of the debt. This method makes practical sense as it minimizes the amount of interest charged. If you apply an extra $1,000 to a debt that is charging 20% interest, you would be saving $200 in interest expense versus $50 if the debt is charging 5% interest.
The Snowball Method
Paying off debt under the snowball method means starting with the smallest amount of debt first, since it can be paid off most quickly and easily. Once the smallest debt has been paid off, you can use that momentum to tackle the next debt. Studies show that there are psychological benefits to paying off loans and reducing the number of creditors and because of this the snowball method is more effective at reaching an ultimate goal of zero debt and the preferred method for paying off credit card debt.
Here’s how it works. If the 5% interest rate debt has only $1,000 in principal, and the 20% interest rate debt has $20,000, the snowball method recommends applying your extra $1,000 to the 5% debt. In doing so you will feel the psychological benefit of paying off a debt, reducing the number of creditors, and simplifying your financial outlook.
Finding the Method that Works for You
There is no wrong answer to paying off debt. If you prioritize the money savings, the avalanche method may be a better fit for you. If you like to build up momentum with small victories leading to larger ones, like a snowball rolling down the mountain, the snowball method is for you. Whichever method you use, once you have reached a manageable level of debt, keep the momentum going and start building a mountain of savings.