If you’re reading this post, you’re likely sitting pretty on some consumer debt. Or maybe you don’t have credit card debt, but you do have a car payment or student loans that are keeping you awake at night. This post will delve into a couple different repayment methods (e.g. the debt snowball vs. the debt avalanche) and discuss the psychology behind both of them so you can pick the method that works for you.
If you don’t already have an emergency fund established, stop right now and go do that first. Emergencies happen, and if you’re trying to avoid any new debt, you’ll want to make sure you have this fund together first.
If you’ve already created your budget, you likely already know all of your minimum monthly payments. List each of your debts (minus your mortgage) and their respective minimum payments individually. You’ll also want to know the current balance and the interest charged for each debt (this may be listed as APR or APY on your statements). Take a close look at your statements as you write everything out. Note for student loan payments: even though you may have one monthly amount coming out of your checking account–you’ll want to write out each of your loans individually for these debt payment methods to work. This assumes you aren’t eligible for or planning to apply for the PSLF program (or Public Service Loan Forgiveness).
Now on to the methods!
The Debt Snowball Method
The Debt Snowball Method is when you list each of your debts from the smallest balance to largest balance regardless of interest rate, Then, you throw any extra money you have at the smallest debt. Say your total minimum monthly payments are $600 and you have $700 in your budget to throw at debt. You’ll continue to make your $600 in minimum payments and throw that extra $100 at the debt with the smallest balance. Once you’ve paid off that smallest debt, (let’s say the minimum payment for this debt was $50), you’ll now have $150 instead of $100 to throw at debt each month. With this method you build momentum as you continue to pay off debts, and that extra money you have to pay toward the next smallest debt keeps growing (hence, the snowball).
A study from the Harvard Business Review at the Boston School of Business indicated that those paying down their debts one account at a time worked harder to pay off their debts and stayed motivated throughout the process. The more early “wins” they had, the more successful they were in paying off their balances.
This method might will cost you a little more in interest in the long-run than the avalanche method, however, it will actually cost you less if you burnout from lack of progress and give up on paying extra for a few months. The psychological benefits gained from erasing one debt from your budget early on in your #debtfree journey will give you the momentum to keep going and paying down your debts even faster. Not only will this method elevate your mood, but it will give you the motivation and self-control to keep pushing forward.
The Debt Avalanche Method
This Debt Avalanche Method is when you list each of your debts from the highest interest rate to the lowest interest rate regardless of balance. From here, you pay all of your minimum monthly payments and concentrate any “extra” money you have at your debt that has the most interest. This usually includes credit cards, as these are often the debts with the highest interest rates. Say your minimum monthly payments are $600 and you have $700 in your budget to throw at debt. You’ll continue to make your minimum monthly payments and throw that extra $100 at the one with the most interest. This method takes longer–but once that highest interest debt is paid off (say the minimum monthly payment is $200), you’ll now have $300 each month to pay on your next highest interest debt. This may take you 11 months, instead of four months with the Snowball method.
This method works if you can always remain intense about your debt repayment. However, you don’t get those early psychological wins like you do with the debt snowball method so it can be easy to lose motivation when you just want those new shoes.
If you’re looking to pay down debt fast, write down each debt’s starting balance, the payment, and the ending balance. Keeping a written record (or an Excel spreadsheet) will help you organize your payments and otherwise continue being a rockstar.
If you’ve already made some progress, let me know in the comments which method has worked for you. Tell us how you celebrated your early wins and what kept you going.