Debt avalanche vs. debt snowball: What’s the difference?

Both forms of debt elimination involve paying off debts one at a time. The primary difference between the two forms of debt elimination is which debts are paid off first.

With the debt avalanche method (also referred to as debt stacking), you pay off the debt with the highest interest rate first. With the debt snowball method, which was popularized by Dave Ramsey, author of “The Total Money Makeover” and radio personality, you prioritize the debt with the lowest balance.

Below, we’ve explored the nuances of each method so that you can figure out which one is ideal for you.

How does the debt snowball method work?

The debt snowball method involves taking a look at all your debt balances and paying them off from smallest to largest. You still pay the monthly minimum balance on all your debts, but put an extra, predetermined amount of money each month toward the smallest debt.

“Once you pay off the lowest balance loan, you would take that extra money and move it toward the second lowest balance,” said Forrest Baumhover, a certified financial planner at Westchase Financial Planning in Tampa, Fla. “At some point, you snowball. All of these principal payments that you were paying toward — all of these tiny loans or credit card balances — are now focused on the last remaining one.”

Who is it good for?

People who benefit from regular motivation. Consumers who opt for the debt snowball method tend to see success due to the “little wins” that go with paying off small debts quickly.

“If the difference in interest rates is not that much in terms of the overall savings, I might tell somebody to go with the snowball method just because they get to see progress sooner,” said Luis Rosa, a certified financial planner with Build a Better Financial Future in Henderson, Nev. “They might have smaller balances that they can get rid of in a month or two, and then they continue to be motivated because they can see some progress at the very beginning of the plan.”

The debt snowball method can also be beneficial for people who have a significant amount of debt in various forms. “The way I see it is if you’re starting with a pretty big number, then a lot of little victories will help you along the way,” Baumhover said.

Does it save you money?

Not necessarily. The debt avalanche method typically makes more sense as you save money on interest. But Rosa and Baumhover said people are often better able to stick to the snowball method because of the satisfaction of “little wins.”

Research from Kellogg School of Management at Northwestern University showed that even though the avalanche method typically leads to more savings, consumers who opt for the snowball method are more likely to eliminate all their debt.

Breaking down how it works

Rosa offers this example:

If a consumer only made the monthly minimum payments on the above debts, it would take them 112 months to pay them off, Rosa said. Adding an extra $200 each month would cut that to 44 months.

Assuming the consumer puts an additional $200 per month (on top of minimum payments) toward paying off their debts from smallest to largest, they will have paid off the personal loan by December 2018 if the above scenario begins in October 2018. With the debt avalanche method, the personal loan will not be paid off until August 2019.

How does the debt avalanche method work?

If you opt for the debt avalanche method, you will continue making the monthly minimum payments on all your debts, but you will put your extra monthly allotment toward the debt with the highest interest rate, not the debt with the lowest balance.

“The key differentiator between the avalanche and the snowball [is that] the avalanche is going to be based on the highest interest rates first,” Rosa said. This means that you’ll likely focus on higher-interest debts, such as credit cards, before lower-interest debts, such as student loans.

Who is it good for?

People who are intrinsically motivated and who aren’t as concerned with the “little wins” that go with the snowball method.

“The avalanche method is typically known to be the most efficient mathematically,” Rosa said. “But sometimes the thing that’s best mathematically isn’t the best for you, because your card with the higher interest rate might be your higher balance card, and you might not see any progress for quite a bit.”

Does it save you money?

Typically, this debt repayment method saves you money, Rosa said. Because you are paying off the debt with the highest rate first, you will see more savings in interest paid.

Breaking down how it works

The benefits of the avalanche method can be seen using the same example as above:

If a consumer puts an extra $200 toward their debt each month and pays it off in 44 months (like the above example), they will not have the quick “win” that accompanies the debt snowball method, but will instead save slightly more on interest. The debt snowball method, in this case, has an overall interest savings of $6,496.82, while the debt avalanche method has an overall interest savings of $6,669.64.

Which debt repayment method is best for you?

Both methods can be beneficial strategies for paying off debt. What it typically boils down to is a person’s mindset and long-term goals.

What does Baumhover typically recommend?

“It depends on the type of client that I’m working with,” he said. “For people that need to tick off little milestones along the way to know that they’re actually making progress, there’s a powerful emotional aspect to [the snowball method]. But when you run the numbers, you do pay a little bit more in interest.”

For people who have intrinsic motivation and don’t need “little wins” to stay on track, the avalanche method might be a better option. “If someone really has a focus on just minimizing the amount of interest, then the debt avalanche would probably be what they would want to do,” Baumhover said.

To figure out which method is ideal for your specific financial situation, you can use this calculator.

5 ways to prioritize and pay off your debt

Now that you know the difference between these two debt payoff methods, it’s time to get started. Here are the first steps you should take once you’ve decided to tackle your debt.

1. Review your debts

Rosa said the first thing people should do is list out every single debt they have by name, APR, balance and minimum payment. Then, he suggests using a free online calculator, which allows you to enter all your debt information and compare different debt elimination methods.

This step is crucial for success. “The debt avalanche vs. the debt snowball, neither of those is going to work for someone who’s not willing to take a look at their whole picture,” Baumhover said.

2. Take a look at your spending habits

Once you’ve identified all your debts, take a look at your spending habits so that you can figure out how much money can go toward your debt elimination plan each month. “[People] should really try to set a realistic expectation of what they’re willing to live on in terms of their budget,” Baumhover said.

The most important thing is to be realistic. Don’t say, “I’ll put an extra $1,000 toward debt each month” without actually taking a hard look at your finances to see if this is possible. You’ll be setting yourself up for failure, Baumhover said.

“It’s kind of like trying to lose 50 pounds,” he said. “It’s not realistic to do it in a month, but if you say, ‘Maybe I need to do it over a year and a half, and I can afford to lose 3 pounds a month,’ then that’s a little bit more sustainable.”

3. Decide which debts you’ll prioritize

This is the point at which you should figure out which debt elimination plan is ideal for you. Are you the type of person who would benefit from small wins each month? Does the idea of eliminating three of your eight debts quickly appeal to you and sound motivating? If so, the debt snowball method is likely the right option for you.

If you have a history of diligence and determination and don’t think the “little wins” would do much for your motivation, then the debt avalanche method might be a better option for you as it’ll lead to more savings.

4. Get advice from an expert

If you’re struggling to prioritize and pay off your debts, consider contacting a financial expert such as a certified financial planner or a nonprofit credit counselor. They can help you take a big-picture look at your finances and offer advice on which strategy is better for you.

5. Stop racking up debt

Rosa said he often sees consumers begin a debt elimination plan and continue racking up credit card debt. This can ruin a debt elimination plan.

“Some people continue to use the cards,” Rosa said. “For example, they might be going after rewards points. The system only works if you no longer use the cards.”

But Rosa added that you shouldn’t necessarily close all your credit cards since this can have an impact on your credit score.

“If you have a credit card from 10 years ago, a major card like MasterCard, Visa or AmEx, you might not want to necessarily close it, even if you paid it off,” he said. “Just continue to use it occasionally, like for gas, [and] pay it off at the end of the month so that you keep that history.”

Another way to pay off your debt: Debt Consolidation

The avalanche and snowball methods aren’t the only ways to manage your debt.

You could take out a personal loan to combine your existing debts. In doing so, you’ll get to make just one monthly payment on a loan with a lower interest rate and different repayment term. This is called debt consolidation, and it’s another repayment strategy that could save you money on interest.

A debt consolidation loan could help you get out of debt faster by reducing the total interest you pay over time. You also get to choose a new repayment term on your debt. So if you want to aggressively pay down your debt and save more money on interest, you could simply choose a shorter repayment period. Compare up to five offers in minutes when clicking “see offers” below. Note: Clicking “see offers” below does not affect your credit.

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Regardless of the repayment strategy you choose, you’re taking a step in the right direction by deciding to take control of your finances and eliminate your debt.

Can you be arrested for debt?

In short, the answer is no. You cannot be arrested for the debt you hold, whether it’s credit card debt, a personal loan, a medical bill, student loans, utility bills, a car loan or any other form of debt that is referred to as civil debt. You can be sued for your debt, but you cannot be arrested. It is illegal for lenders and debt collectors to threaten to arrest you for not paying back your debt.

“Debt collectors can’t threaten to arrest someone,” said Barry Coleman, vice president of counseling and education programs for the National Foundation for Credit Counseling. “They can’t make threats to intimidate people.”

There are a handful of situations, Coleman said, in which threatening to arrest someone can be a legal option. This would apply in rare cases in which the arrest would be related to something tangential to the debt — such as fraudulent activity, identity theft or defying a court order — but not the debt itself.

“We always say: If someone gets an order to appear in court, even if they know they legally owe that debt and they can’t pay it right then and there, show up in court,” Coleman said. “Because if you don’t, then you will face other consequences.”

Also, consumers can be arrested if they cheat on their taxes or don’t pay child support debt, according to Coleman. “Those types of debt are a little bit different,” he said.

What should I do if a lender threatens to arrest me?

A lender threatening to arrest a debtor violates the Federal Trade Commission’s Fair Debt Collection Practices Act (FDCPA), according to John Ulzheimer, founder of The Ulzheimer Group and a credit reporting expert who worked for FICO and Equifax.

“You’re not allowed to use abusive tactics to collect debt,” Ulzheimer said. “And certainly indicating or suggesting to somebody that they can go to jail if they don’t pay [their debts] is illegal.”

If a lender threatens to arrest you, there are a few things you can do. You can do nothing and hope the threats stop, Ulzheimer said. (It is wise to document the threats of arrest, however, in case you need to take future legal action against the lender or debt collector.)

You can also leverage your rights under the FDCPA and file a lawsuit against the debt collector for abusive debt collection practices.

Coleman adds that you can report the lender to the Consumer Financial Protection Bureau (CFPB), and someone with the bureau will follow up with you about the complaint.

“Both the [CFPB] and the Federal Trade Commission have authority to pursue action if a debt collector is threatening something that they can’t legally do,” Coleman said.

What can happen if I don’t pay back what I owe?

Consequences for not paying back debt vary by state, but there are some federal regulations on unpaid debt.

Although you cannot be arrested for your debt, there are a handful of other things that can happen. “There are a lot of bad things that can happen when you don’t pay your debt,” Ulzheimer said. “Nothing good comes from not paying your obligations, right?”

If you don’t pay back your debt, it will go into default. Once in default, creditors will typically try to collect the debt themselves, Ulzheimer said. Your credit report and score will be negatively affected, and you will likely receive phone calls and letters.

If you still don’t pay back your debt, the lender will likely sell your debt to a third-party collection agency or debt collector. “They will eventually get sick and tired of attempting to collect the debt and they will either sell the debt or consign the debt to a debt collector,” Ulzheimer said. “If the debt is large enough or if the debt collector chooses to, they can file a lawsuit against you.”

If a debt collector files a lawsuit against you, you should show up to court no matter what. If you don’t show up, the collector can get a default judgment against you.

Coleman said one potential repercussion of not paying back one’s debt is court-ordered wage garnishment. That means the debt collector can legally seize a portion of your paycheck before the money hits your bank account.

“Wage garnishment, I think, is probably the biggest repercussion of not paying a debt,” he said. “It is probably the biggest concern for folks that are behind on the debt and aren’t trying to work with that particular creditor or debt collector.”

How to fix your debts

If you’re struggling to pay back your debts, there are a handful of important steps you can take to get on solid financial footing.

1. Don’t ignore your lenders or debt collectors.

Even if you can’t afford to pay back your debts, one of the worst things you can do is avoid your lender or debt collector. Answer the lender or debt collector’s phone calls, and, of course, any court summons you receive.

“Consumers will want to be proactive and work with their creditors and any debt collectors when they owe debt to work out some sort of an arrangement to avoid it escalating and becoming an even bigger situation,” Coleman said.

2. Negotiate with your lenders.

Some consumers might not be aware of this, but you can negotiate your debts with your lenders. Contact your lender and explain your financial situation. Tell it that although you cannot repay the entire debt, you can pay X amount each month. If you have extenuating circumstances, such as the loss of a job, illness or a death in the family, tell the lender.

“If you don’t have the means to pay, just be honest and state that,” Coleman said. “If you can pay a little bit, offer to do that. If the lender says, ‘OK, I’ll accept this payment arrangement,’ just ask that it be in writing so that you have something to back that up.”

3. Seek help from a nonprofit credit counseling agency.

If you’re struggling to repay a significant amount of debt across multiple channels, consider contacting a nonprofit credit counseling agency. Counselors at these agencies can help you come up with a plan for repaying your debt and can negotiate with lenders on your behalf if necessary.

4. Consider using the debt snowball or debt avalanche method for repaying debt.

These are two common strategies consumers use to repay their debt. The debt snowball method involves paying back debts from smallest to largest, while the debt avalanche method involves paying back higher-interest debts first.

5. Consolidate your debt.

If you have multiple debts and are struggling to stay organized, consider taking out a debt consolidation loan (nonprofit credit counselors can help in this area). This involves consolidating all your debts and making one monthly payment that gets distributed among your various creditors. If you have a fair credit score, you may even be able to snag lower interest rates, which could save you money in the long term.

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Terms

24 to 60

months

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Although you cannot be arrested for debt, there are myriad consequences that can result from not paying back what you owe. Ignoring your debts or any court-ordered summons will only make your situation worse. Be as proactive as possible to avoid the repercussions of not repaying your debt.

Good debt is debt that in some way contributes to your financial future in a significant way.

“When people are financing either assets or other things that have some sort of true and intrinsic value — and maybe even an ascending value — then you can make a pretty good argument that it’s good debt,” said John Ulzheimer, founder of The Ulzheimer Group and a credit-reporting expert formerly of FICO and Equifax.

Gerri Detweiler, a consumer credit expert and author of Debt Collection Answers: How to Use Debt Collection Laws to Protect Your Rights, said good debt boils down to whether someone comes out of debt with something to show for it.

“I think overall, generally good debt is debt where you come out ahead,” Detweiler said. “Whether that’s investing in a home that’s later paid for and provides you with a place to live, or an education that results in higher earning power over your career, or even small business debt that allows you to start or grow a small business that brings an income — those are all examples of debt that can be good debt.”

But Detweiler adds that all forms of good debt must be looked at on a case-by-case basis.

“[They’re not] automatically ‘good’ debt, because it’s possible, of course, to get into a house that ends up being a money waster,” she said. “You could end up spending a lot of money for an education and not be able to translate that into a career or a steady income. Or you could invest in a small business that fails. There’s no guarantee that those types of debt that are often good will be good for you. You have to be sure you’re making a smart decision.”

Experts agree that generally speaking, the following are all forms of good debt.

Mortgages

A mortgage taken out to finance a home is considered a good debt because as a buyer, you are investing in a piece of property that will hopefully provide you a return on investment one day. And depending on your income level, a mortgage could provide a deduction on your taxes.

“You can make a pretty strong argument that debt incurred to buy a home is good debt, presuming that you’re buying a home that is going to appreciate over time, and when you sell it someday, you’re going actually make money out of it,” Ulzheimer said.

Mortgages also tend to have lower interest rates than other types of loans. The average interest rate in the U.S. for a 30-year fixed rate mortgage is currently 4.55 percent, according to the Federal Reserve Bank of St. Louis. On the other hand, the average interest rate for new credit cards in the U.S. is nearly 14 percent, according to the Federal Reserve Bank of St. Louis.

Student loans

Perhaps the most valuable debt someone will incur in their lifetime, according to Ulzheimer, is student loan debt to pursue a college education.

“I think studies are pretty clear that people who have a college degree over their lifetime are going to earn more than people who do not,” Ulzheimer said. “In my mind, that may be the best of all debts in terms of return on investment.”

Interest rates on federal student loans vary, but currently sit between 4.45 and 7 percent, according to the U.S. Department of Education.

The earning potential for college graduates is starkly higher than that of non-graduates. Men with a bachelor’s degree earn an average of $900,000 more in their lifetime than men with only a high school education, while women with a bachelor’s degree earn an average of $630,000 more in their lifetime than their high-school educated counterparts, according to data from the Social Security Administration. The numbers only increase with graduate degrees: Men earn an average of $1.5 million more and women $1.1 million more in their lifetimes than those with only a high school education.

Small business loans

Taking out a small business loan can be beneficial — investing in a small business, assuming it succeeds, means investing in something that could provide you significant future earnings.

Loans guaranteed by the Small Business Administration (SBA), for example, typically have lower down payments, lower interest rates and flexible overhead requirements, according to the organization.

“You’re making an investment in yourself, in your future, in your business,” said Kathryn Bossler, a credit counselor with GreenPath, a nationwide consumer credit counseling agency.

That being said, there are some very high-cost short-term business loans available that could cause a strain on your bottom line; approach these with caution.

Home equity loans

Home equity loans fall into the “good” category because they allow someone to borrow against him or herself (instead of from an outside lender) to make a large purchase or investment, or to pay off debt with a higher interest rate.

In addition, home equity loans typically come with lower interest rates — they range from about 4.25 to 6 percent, according to LendingTree — and can help someone consolidate and pay back other higher interest rate debts.

However, home equity loans used for the wrong purpose, such as financing a vacation or an unnecessary large purchase, could become a form of “bad” debt — ultimately, it all depends on what the home equity loan proceeds are used for.

When Detweiler was in her 20s, she went to Sears and got approved for a credit card. She purchased a couch, an answering machine and a lamp. “Before that debt was paid off, the couch had a rip in it, the answering machine had been zapped by lightning and the lamp was broken,” she said. “I still had a bill, and nothing to show for it. That’s definitely bad debt.”

Detweiler said “bad” debt is debt in which the borrower has nothing to show for it, save for the fact that they’ve spent a significant amount of money.

Forms of bad debt typically come with very high interest rates, making it difficult for borrowers with significant debt to pay it back in a timely manner.

Experts agree that generally speaking, the following are all forms of bad debt.

Credit card debt

Credit card debt is perhaps the most pervasive form of “bad” debt in the U.S., with 121 million Americans currently carrying credit card debt. The average credit card debt per person is $4,453, while the average credit card debt per household is $8,683.

Credit card debt falls into the “bad” category mainly because of the high interest rate that often accompanies credit cards. In fact, the average interest rate for a new credit card in the U.S. is around 14 percent, according to the Federal Reserve Bank of St. Louis.

“Typically, it’s a red flag if you need to carry a balance on your credit card,” Bossler said. “Credit cards are really designed for convenience. There are lots of consumer perks in terms of points and rewards … But carrying a balance is probably going to come with a high interest rate, and is promising money that you don’t have right now.”

Luckily, consolidating credit card debt can help borrowers pay it back more quickly than they might be able to pay back other forms of “bad” debt.

Payday loans

Payday loans should be avoided at all costs.

“I think the worst of the worst, most people would agree, would be payday loan type debt, because the interest rates are so high and the repayment requirements are so immediate,” Bossler said. “And usually someone who is taking out that type of loan is in serious financial distress.”

Because payday loans are typically smaller and paid back in a couple of weeks, borrowers might not feel their impact. But that doesn’t mean it’s not there.

“They’re called ‘lenders of last resort’ for a reason,” Ulzheimer said. “Their interest rates are, when you annualize them, in some cases several hundred percent APR. You don’t feel that because they have short-term amortization schedules.”

Some debts may not be inherently good or bad. It all depends on how you use them.

401(k) loans

Borrowing against your 401(k) might not seem like a terrible decision in the short-term — after all, you’re taking out a loan from yourself — but it can come with a number of consequences. Ulzheimer said he often sees people take money out of their retirement accounts to pay off debt, but then fail to pay back their 401(k) loan.

“You’re almost compounding the problem by doing something silly like that,” he said. By not paying it back, people face countless consequences, including delaying their retirement plan, potentially paying more in taxes (401(k) funds are pre-tax), and potentially paying a penalty for not paying back the loan in time.

In addition, if someone leaves a job before paying back their 401(k) loan, he or she must repay the loan over a set period of time or it could be treated like a distribution and taxed accordingly.

Auto loans

Auto loans fall into the murky territory between good and bad. A car can be a necessary purchase for many people. And someone with the right financial know-how can take on an auto loan that is neither bad nor good, but rather necessary.

However, Detweiler said people often get swept up into higher car payments than they can afford, which can lead to a situation in which someone is paying for a car that is either not running or not worth investing in anymore. “You really have to be on guard when going into debt for something like a car, because it’s very easy to get talked into or psyched into spending more than you can afford.”

Bossler said that when she first began working as a credit counselor 12 years ago, three to five-year loans were common. Now, because cars are more expensive and because consumers want the lowest interest rate possible, she’s seeing terms as long as 72 and 84 months.

“That’s when I would say we’re getting into dangerous territory,” she said. “The car is probably not going to be worth what you owe a couple years down.”

Installment debt is a standardized loan that is paid back in installments that are typically monthly. Mortgages and auto loans are common forms of installment debt. The amount the borrower pays typically remains the same month-to-month.

Revolving debt, on the other hand, doesn’t have a set amount to be paid by the borrower each month, though there is a limit to how much a borrower can use. Credit cards and home equity lines of credit are common forms of revolving debt, because credit is borrowed, then paid back, then borrowed again in a revolving manner, with the amount changing each month.

Both forms of debt affect your credit report and credit score, though revolving debt is typically seen as riskier by the credit bureaus, as credit scores often hinge on the amount of available credit a consumer uses. Installment debt is often associated with an asset (i.e. a home or car), making it a safer form of debt in the eyes of credit bureaus.

It’s generally viewed as positive to carry a mix of both installment and revolving debt, with fewer of the latter in your credit mix. Credit mix makes up 10% of your credit score.

How to eliminate debt

Regardless of what type of debt you have, paying it off in a timely manner is crucial for achieving financial freedom. Keep these best practices in mind when you begin paying off your debt.

1. Know your interest rates.

Detweiler said she has spoken to countless consumers who have no idea what their interest rates are. They will throw money at a debt trying to get out of it before actually looking at what the numbers say.

By taking a look at the interest rates for all of your loans, you can determine whether refinancing or consolidating is a good option. Or, you can identify which loan has the highest interest rate, and then prioritize paying back that loan first.

2. Consider refinancing your debt.

Getting a lower interest rate on your debt can be integral for paying it off. “While you’re paying off debt,” said Detweiler, “look at whether you can refinance some of that debt to make the interest rate less expensive.”

For personal loans, such as mortgages and student loans, this could mean refinancing to get a lower rate. For credit card debt, it could mean taking on a lower-interest consolidation loan or transferring a balance to a card with a better interest rate.

3. Establish your priorities.

Ulzheimer said you should first ask yourself what your priority is. Is your priority to get out of debt as quickly as possible? Is it to pay down your most expensive debt first? Is it to eliminate nuisance balances on retail store credit cards? Is it to improve your credit score?

Once you identify your priorities, you can begin effectively paying off your debt.

One strategy Ulzheimer recommends for paying off credit card debt is paying down the cards you use the most while also paying off your nuisance balances.

“Credit scores hate balances on credit cards, and credit scores hate to see highly leveraged cards, to the extent you can take care of those first,” Ulzheimer said. “A. You’re getting out of debt which is good, and B. Your credit scores are going to start to improve because your utilization ratios are going to go down, and the number of accounts you have balances with is also going to go down.”

4. Be conscious of the credit you use while paying off debt.

Bossler said she would advise someone looking to get out of debt pursue the strategy that is not only going to give them the best interest rate, but is also going to stop them from using the credit again and digging themselves into the same hole.

“What we see sometimes is that people will refinance their home or take out equity to pay off credit cards or get into those 0 percent interest credit cards, and then go back around and use the old cards again,” she said. “Something we talk a lot about with consumers is yes, we have this strategy to address your debt, but what are the other steps you’re going to take to avoid it again?”