Snowball vs Avalanche: Which is best for debt reduction?
If you read the first few words of the title and are wondering how in the world is a snowball or avalanche going to help you pay off debt, don't worry, I'm not crazy.
The two terms were popularized by the personal finance guru, Dave Ramsey. If you're not familiar with any of Dave's work just give him a google search and you'll soon be swarmed with information about him, his business, all things personal finance and how he's helped millions overcome their debt with his "Baby Steps" wealth building method (which I'd highly recommend by the way).
But this blog post isn't about Dave and his teachings. It's about the two most popular ways to slay your debt. We'll dive into each in detail soon enough, but first let's talk about debt.
Living with debt
Growing up, most of us are taught that the responsible adult thing to do is get a job, save a minimal amount of money, get a car loan, get a credit card and then one day get a mortgage for a house you likely can't afford.
That's the great Australian dream, right?... and the American dream... and most of the worlds dream. It's "normal" to live like this.
Nearly 80% of people live their lives constantly thinking about what they've got to pay next and to whom. It can take a toll on you, both financially and mentally.
The world we live in today has everything at our fingertips, thanks to technology like smartphones, high speed internet, streaming services... the list goes on. Companies pay millions, sometimes billions of dollars each and every year on advertising aimed at attracting you to their products and services. Their complex algorithms are so advanced they can place images in front of your eyes that have a high likelihood of you clicking on them, which can (and usually does) lead to a purchase of some sort.
With these kind of strategies and the introduction of "buy now, pay later" schemes, it's no wonder the majority of the world lives their lives in debt. Not the good debt either. I'm talking about consumer debt - the type of debt that has no potential of making you money and depreciates in value over time. It's just too damn easy to spend money that you don't have!
If you're anything like us, you will likely get to a point in your life where you ask yourself "Surely there's a better way to live than constantly being in debt?" If you're not at that point yet and still have personal loans, car loans or any other debt that doesn't make you money and you're ok living like that, I'm here to tell you that your life could be a whole lot better without that debt hanging over your head.
Maybe you're at the stage in your life where you are sick of living in debt and want to make a change. That's great! If you're stuck on where to start, I get it. It can be overwhelming when you first get started on your debt reduction journey. Hang in there though! Let me introduce you to the most popular debt reduction method first. The Debt Snowball.
The Snowball Method
The snowball method of debt reduction has you list out your debts from smallest to largest, and start by going HAM on the smallest debt until it's fully paid off. You still make the minimum debt repayments on anything you else you are obliged to, but you shuttle everything else toward paying off the smallest debt first.
Once you've knocked the smallest debt out of the park, you apply that same ravenous behavior to the next smallest debt. You continue this approach until you have no high interest debt remaining. "High interest" refers to anything over 5 or 6%, which is usually your credit cards, personal loans, car loans, etc. Once you are done, you would usually only have your mortgage remaining.
In summary, this is the snowball approach:
List your debts from smallest to largest, regardless of their interest rates
Make the minimum repayments on all other debts your are obliged to pay, except the smallest debt
Pay as much as you can towards the smallest debt until it's paid off
Move onto the next debt on the list and repeat until you have no debt except the mortgage remaining
After I wrote those steps I googled "the snowball method" and my wording is nearly exactly the same as what shows up from Dave Ramsey! But to be fair, I don't think there's many variations to write those 4 basic steps.
By far the biggest benefit of using this method is the positive psychological effect is has on you. By paying the smallest debt first you give yourself a quick mini-victory. You prove to yourself that you CAN do it and that paying off debt IS possible. It get you "runs on the board" very quickly which gives you the motivation to keep going.
The snowball method isn't necessarily the best use of your debt reduction money, mathematically.
When you list your debts from smallest to largest regardless of their interest rate, you could be faced with a situation where your smallest debt could be $240 with no interest and a credit card debt of $3000 with 19% interest, as an example.
By using the snowball method you would pay the $240 debt off first, which is great, but your $3000 credit card debt with be costing you close to $50 in interest each month it's left unattended!
The Avalanche Method
The debt avalanche method is a way to pay down debt by paying off the debt with the highest interest rate first. You will make the minimum repayments on all other debt obligations, but throw everything you have at getting rid of the highest interest debt first.
From there, you will move onto your next highest interest rate debt and continue until the only debt left is the mortgage.
The usual culprit that will be up first is the credit card. Credit cards can have APR %'s higher than 22% in some cases. That's madness! Not too far behind is usually personal loans at around 9%, then student loans, car loans and so on.
So in summary, this is the avalanche approach:
List your debts in order of the their interest rate. Highest at the top
Make the minimum repayments on all other debts your are obliged to pay, except the highest interest debt
Pay as much as you can towards the highest interest debt until it's paid off
Move onto the next debt on the list and repeat until you have no debt remaining except the mortgage
The steps for both the snowball and avalanche are fairly similar, as you can tell, with the only real difference being the debt order.
The avalanche method will save you the most money on interest payments due to the fact that you're paying the highest interest debts first. With this method you will spend less money overall to pay down your debts as compared to the snowball method in most cases.
The con here is the opposite to the pro of the snowball method. With the snowball method you get the positive psychological impact of knocking off a debt fairly quickly. However with the avalanche method you could have a fairly high debt sitting at the top of the list, which could take you quite a while to pay off.
Chipping away week after week at a high value debt can seem like you're not making much progress, and it can be demotivating for some. If you have the $3000 credit card debt from our example above and can only manage to pay an extra $200 a month toward the debt, it can take over a year to pay off!
So which method is better?
No doubt this question has been in your mind the whole time you've been reading this article. Either that, or you skipped straight to this section to find out "which one is better?".
Let's use a side-by-side example to help illustrate how both methods would work. We'll use the same debt scenario but use the two different debt reduction methods.
For both of these scenarios the extra amount per month put towards debt is $300. The snowball will start with the lowest value debt and the avalanche will start with the highest interest debt.
So which method is the financial winner in this scenario? If we go strictly by the numbers, the avalanche method is the winner.
By these calculations you see that using the avalanche method will save you $6,166 and have the debt paid off one year quicker when compared to the snowball method. Whichever method you choose in this scenario, it's still a long time to pay off all of the debt.
In a real life scenario you would likely throw more than $300 a month extra towards the debt. the more you can free up, the quicker the debts are paid and the more money you will save.
Regardless of which debt reduction method you choose, the most important thing to remember is that you've chosen to tackle you debt with vigor. For that, you deserve a pat on the back and a high five! The fact that you're reading this blog post means you're different from 80% of the worlds population. It means you're sick of debt and are making a plan to eliminate it from your life.
While the avalanche method might make the most financial sense when you crunch the numbers, the snowball method can't be overlooked for the momentum it can build from ticking off smaller debts fairly quick.
It's also worth noting that it doesn't have to be "one or the other" either. The single best method for debt reduction is the one that you will be most consistent with, and that could mean using a mix of both methods if that works best.
You can start with the snowball to knock out a few quick debts, then switch to avalanche to tackle the credit card debt. Or you could knock out the credit card debt first and then switch to paying a few of the smaller debts. There's no right or wrong way. If you do what works best for you and your situation and you're able to stick to it, then that's the perfect debt reduction plan.
Blake - FIRE with a family