Have you lost your way in the labyrinth of multiple debts? Does every paycheck received seem to laugh in your face because it is another sure shot into your lenders pocket? Well, do not lose hope. Financial gurus suggest a number of approaches to come out of financial crisis. Among them, debt snowball and debt avalanche are two popular choices. Many people believe that debt can play an instrumental role to save them from scary things like bankruptcy. Can they really help you to climb up from the trenches? Which one is the right choice for you? Let’s discuss.
A closer look at debt snowball
Popularized by the famed financial expert and radio talk show host Dave Ramsey, debt snowball, is a much talked about concept. How does it work?
It is a process by which you pick the smallest debt to pay off first and gradually move towards the bigger ones. So order your debts by size (from lowest to highest).
Allot as much as possible to the smallest debt while paying the minimums on the rest. Concentrate on the smallest loan to make sure that it is paid off as soon as possible. Your credit standing, however, does not take a hit as you continue making minimum payments on every other balance.
After you succeed in paying off the smallest debt, move to the next one. Since you have one less debt than before, you can put the extra money to eliminate it faster. As you clear off your debts one after another, the amount of cash that you can use increases. This helps you to get rid of your debts relatively faster.
Debt snowball is certainly an effective way to extricate yourself from debt. It is best suited to revolving debt like credit card debt. A debt snowball calculator can help you to manage things better.
Debt avalanche-an evolved form of debt snowball
You cannot keep away debt avalanche while talking about snowball. It is quite similar in approach to debt snowball. With debt avalanche you order your debts by interest rate (from the highest to the lowest). You need to throw as much as possible at the debt with highest rate of interest while paying the minimums on the rest. After you succeed in paying off the chosen debt, target the next highest interest debt. Proceed in the same manner till you are a debt free and happy man.
Mathematically speaking, debt avalanche is cheaper and faster way to get out of debt than debt snowball. With debt avalanche you get rid of the most damaging debt first because higher interest rate would mean that eventually you have to pay more. You need to pay the minimum amount of interest if you use this method.
Debt avalanche vs debt snowball
There has been much debate on which is the best debt reduction method-avalanche or snowball. Debt snowball focuses on the emotional side of human beings. It assumes that paying off the smaller debts will give you a sense of victory. This early success will motivate you to pay off the rest of your debts. Debt avalanche on the other hand has a more rational appeal. If you believe that good financial decisions are rational decisions then avalanche is perhaps the way you should go. It helps you to save more bucks than debt snowball by eliminating the debt with highest interest first. Avalanche has been often criticized as it doesn’t take into consideration the “human element” or “motivation factor” in the debt reduction process. It can be argued that people can always set their own milestones like paying off the first $1000. Reaching that mark may have the same effect on human psychology as paying off the first debt.
Which is the right choice for you?
Debt snowball is suitable for people who prefer quick results, are essentially emotional by nature and want a debt reduction plan that is simple to follow. It can be very effective for people who have a wide range of balances. It gives you tangible results and motivation to follow through-something that is missing in many debt reduction methods. However, it is not the fastest process of debt reduction and is certainly not the cheapest one. People with an analytical bend of mind would be more benefited by debt avalanche which can maximize the use of your money.
You must realize that being debt-free is not just a dream but a distinct possibility. All you need is discipline and a solid financial plan. Both debt snowball and debt avalanche can play an instrumental role to lead you to a debt-free destination. Make sure that you stick to whichever method you choose and remember what Dave Ramsey said- “you can’t go wrong with getting out of debt”.
David Brown is a content writer with Oak view law group. He writes on a variety of finance related topics with a strong focus on debt.