What is the best method to pay off debt? If you’re buried in debt you are probably stressed out and looking for a way to get things paid off as quickly as possible. Well, you’re in the right place because in this video I’m going to share with you the two most popular methods for paying off debt – the debt snowball and the debt avalanche. I’m also going to cover the pros and cons of each and help you figure out which path is the best one for you.
If you’re buried in debt you are probably stressed out and looking for a way to get things paid off as quickly as possible. Well, you’re in the right place because in this Article I’m going to share with you the two most popular methods for paying off debt – the debt snowball and the debt avalanche. I’m also going to cover the pros and cons of each and help you figure out which path is the best one for you. Are you ready? Let’s go!
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The debt snowball method was made popular by finance expert, Dave Ramsey. The idea of this method is to pay off your smallest debts first, and then move on to the bigger ones. Just like a snowball picking up steam as it rolls down the mountain, you start by paying off the smallest debt, putting as much extra money as you can into each payment for that specific debt. On the rest of your debts, you only pay the minimum amount required. Once the smallest debt is paid off, you take the money you were using to pay that first debt and apply it to the next-smallest one. One of the best things about eliminating the amount of debt accounts faster, is that you have fewer payments to worry about each month. The other big benefit – and the main reason this approach is so popular – is because you’re quickly seeing your debt accounts paid off, it has a huge psychological impact.
It makes you feel happy and motivated, which encouraged you to keep up with your debt payments. However, the biggest drawback to this method is that, over time, you’ll end up paying more in interest than the next method. So, this method doesn’t save you a lot of money, but it does provide amazing mental relief. Let’s say you have three debts: A, B, and C. Debt A is for $100 with 3% interest, B is for $1000 with 10% interest, and C is for $10,000 with a whopping 24% interest. With the debt snowball method you would start by putting all of your extra money each month towards Debt A, while maintaining minimum payments on Debts B and C. Of course, with the highest interest rate, Debt C’s payment is barely paying anything towards the principal of the loan, but you get the satisfaction of paying off Debt A pretty quickly.
Then you take everything you were paying towards A and move it to B.Now you’re paying much more towards B each month, which increases the speed of B’s pay off. By the time you get to C, you feel pretty good since you only have one account left. But, it’s a big one, and you’ve been paying a lot towards interest so you still have a ways to go.
The opposite of the snowball method is the debt avalanche. In this method, you focus on the interest rates of your loans and starts with the highest interest rate debt first. This gives you the advantage of saving more money on the interest payments and working down your principal faster. The downside is that you may feel like you’re making less progress than you would with the debt snowball method. In this case, discipline is important. All excess money must go towards the debt with the highest interest, even if it is your largest account. It is slower, yes, but you end up saving money in the long run. To show you how a debt avalanche works, let’s look at another example.
Let’s say you have three debt accounts, and each has a different interest rate. Let’s say you owe $20,000 in credit card debt with an interest rate of 15%, followed by a $3,000 car loan with a 3% interest rate and a $10,000 student loan with a 5% interest rate. In a debt avalanche method, you also pay your minimum payments on each account, but any extra money you have will go towards paying off the debt with the highest interest rate first. That would be the credit card debt with the 15% interest rate.
Over time, by focusing on the principal of the loan, this saves you the most money. The challenge with this is that, since you owe the most on your credit card – $20,000, it is going to take you much longer to pay off your first account. This can have some negative psychological impacts since it doesn’t feel like you’re improving your situation as fast as you would with the debt snowball method. Once the credit card is paid off though, you then pay off the student loan with the 5% interest rate.
By the time you get down to your smallest debts, you’re able to pay them off very fast since all of the money you were putting towards your large interest payments are now applied to these. The speed of account pay offs increases over time, which is the opposite of the debt snowball which pays off accounts quickly to start. The debt snowball strategy provides you with dopamine boosts and makes you feel like you’re making progress on debt payments. With those same three debts – the credit card, the car loan, and the student loan, if you were going to use the debt snowball method, instead of paying off the loan with the highest interest rate first, you pay off the smallest amount, which is the car loan at just $3,000.
Let’s say you finish it in about three months and then move on to the next two. Studies show that people are more likely to stick with the debt snowball than the debt avalanche method since they can quickly see improvements in their debt situation. The debt avalanche and debt snowball methods apply to most types of consumer debt, like a personal, student, and auto loans, credit card balances, and medical bills. But these two methods don’t work as well with mortgage payments and shouldn’t be tried with them. This is mainly due to the substantially higher loan amount and lower interest payments you usually have with this type of debt. Even though both are good ways to get rid of debt, one might be easier for you to stick to and have a more significant impact on your finances. At the end of the day you should pick the one that works best with your personality, because that is the one you are more likely to stick with. When you finally get your debts paid down it can feel like a huge weight has been lifted off your shoulders. But not all debt is the same.