When it comes to debt repayment strategies, the debt snowball method gets a lot of press.
This is the approach where you order all of your debts by balance and prioritize your lowest balance debt first. Once that’s paid off, you prioritize the next lowest balance, and so on.
It’s an approach that was popularized by Dave Ramsey and these days it seems to be the go-to strategy for most people in debt.
And the truth is that it’s a great way to pay off your debt. Paying off those lower balance loans can be motivating, and the simple fact is that the debt snowball method has gotten a lot of people out of debt.
But the other truth is that it might be costing you money.
There’s another approach that can not only get you out of debt sooner, but leave you with more money in your pocket.
It’s called the debt avalanche and it prioritizes your high-interest debts first. And in this post, we’ll look at an example to see just how much money it might be able to save you.
Let’s Meet our Example Couple
Pete and Lisa are a young married couple and are very much in love. They share everything. Stories about their days. Toothpaste. A love for all things Vin Diesel.
Oh, and their debt. They share that too. And they would like to get rid of it as soon as possible.
Here’s what they owe:
- Car loan: $5,000 balance at 3% interest, with a $71.87 minimum payment
- Student loans: $10,000 balance at 6.8% interest, with a $115.08 minimum payment
- Credit card: $15,000 balance at 13% interest, with a $312.50 minimum payment
So what’s the best way for them to attack this debt? Let’s compare a few different approaches and see which one will save them the most money.
For each option, I’m going to use this Debt Snowball Calculator to calculate the time to payoff and total interest paid.
Option 1: Paying the Minimums
The default option is to simply keep making those minimum payments. If they just do that, here’s what it would look like for them:
- Time to debt-free: 10 years (121 months)
- Total interest paid: $10,596
That’s a long time! But they know they can do better, so the real question is which accelerated payment method is right for them.
Option 2: Debt Snowball
Pete and Lisa are serious about tackling their debt, so they’ve cut some unnecessary expenses out of their life, automated their budget as much as possible, and now they have $200 extra to put towards their debts each month.
Not only that, but with each debt they pay off they’re going to take the money they were putting towards that debt and start putting it towards the next one. In other words, they’re making moves!
So the real question is how to prioritize those extra payments: lowest balance first or highest interest rate first?
Let’s look at how they would fare with the debt snowball approach first. With this strategy, that extra $200 is going to their lowest balance debt first (the auto loan), then the next lowest (the student loans), and finally to their highest balance debt (the credit card).
Here are the results:
- Time to debt-free:5 years (54 months)
- Total interest paid: $7,514
- Savings over minimum payments: $3,082
Not only were they able to shave over five years off their debt repayment plan, but they were able to save themselves $3,802 in the process. Pretty sweet!
Obviously the debt snowball approach is better than simply paying the minimums, especially if you can tack on an extra monthly payment. But is it the best approach?
Option 3: Debt Avalanche
This time, we’ll assume that Pete and Lisa are approaching things in exactly the same way, except that now they’re prioritizing their debts with the highest interest rates.
This is the debt avalanche approach, and it has them putting their extra money first towards their credit card, then towards their student loans, and finally towards their auto loan.
How does that work out for them?
- Time to debt-free:3 years (51 months)
- Total interest paid: $5,672
- Savings over minimum payments: $4,925
- Savings over debt snowball: $1,843
Compared to the debt snowball approach, it gets them debt-free 3 months sooner (pretty cool) AND saves them $1,843 (very cool!).
How much money can you save?
Before you jump head first into your own debt snowball, I would encourage you to run the numbers for yourself and see if you should go with the avalanche method.
You never know how much you could save.
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