To really get a grip on our debt, we need to become the boss with a plan to remove it from our lives. We all do this differently based on our preferences. Some will tackle debt like a fierce lion or lioness where others will handle it like a family pet. Ideally, the best way is to get rid of the leach on your finances as fast as you can.
What I want to talk about is the two methods there is to tackle bundles of debt (more than one account) and what the pros and cons of each one are. If you’re in the case of a single account, find ways to increase your payment towards it and you’re solid! Why not just suggest this for multiple accounts? well, I’ll get to that.
Of the two methods, I’ll be starting with the debt snowball method. Dave Ramsey highly recommends this method to his followers as it brings quick wins (or feedback) for those that carry out the method. The snowball method calls for paying more towards smaller balance debts while paying the minimum for all other accounts. So if we have $200 to put towards $1,000, $5,000, and $10,000 of debt with each having a minimum due of $25, we would put $150 towards the $1,000 balance first. Once that’s paid off, then put the $175 towards the $5,000 and finally $200 towards the $10,000 balance.
The quick wins come from seeing that debt being squashed when balances reach 0 and/or accounts are being closed. As from the example, the payment towards each balance grows as we pay off accounts; this is the snowball effect rolling down a hill gaining more snow. On the last account, we were paying all we could towards it.
The point of this method is the quick wins, not necessarily the quickest or cheapest payoff. The quick wins keep the train of motivation moving forward.
The debt avalanche method takes a different approach to pay off debt than the debt snowball. The objective is to pay as little in interest while also paying the debt off sooner. In this method, you’re taking the balance with the highest interest rate and targeting that first. This could be the smallest balance or the largest. The debt snowball only cared about balance, avalanche only cares about the interest rate.
Check out this snowball vs avalanche calculator to see the difference.
As an example, if we have a debt of $5,000 at 5% and $10,000 at 10%, the minimum payment is at least $250/month. If we have $350 to pay towards the debt, we could save close to $500 in interest using the avalanche method. You could pay off the $5,000 balance faster, but the objective here is to save money in the long run.
Remember the objective of this method is to save money in the long run. This means sometimes waiting longer for the reward.
You’ve now been equipped with 2 methods to choose from for helping pay down your debt. The next step is to make a plan and stick to it! Maybe you start with a snowball, pay off some debt, and switch to avalanche or maybe Vise-Versa. The plan is yours to own and control. Find ways to track your progress and keep yourself motivated.