Between the two major debt repayment methods available today, only one promises to save you money. This cold-hard fact should make your decision easy: choose the money-saving option, obviously. Well, not quite — human behaviour doesn’t always follow logic when it comes to personal loans.
Comparing the 2 Major Debt Repayment Methods
The financial world recognizes two official strategies for paying down debt: avalanche and snowball.
Before you choose between these methods, you need to organize your debt. Make a list of every account with the amount you owe. Note the monthly payments and due dates for every personal loan, credit card, and online line of credit.
Regardless of the method you end up choosing, you always have to cover the monthly payments. Hitting monthly minimums ensures you avoid late fines on all your accounts, so you don’t slip into delinquency with one account while paying down another.
By choosing between the avalanche and snowball method, you decide which account you want to pay off first.
The Avalanche Method
The avalanche method involves arranging your list of debts by interest rate. Look at the account with the highest interest rate — that’s the one you will pay off first.
Once you pay off that account, take the extra money you once put towards the first debt and roll it into the account with the next highest interest rate. Keep up this process until you move through every account and pay off the last cent.
By paying off the highest interest rate first, there’s a good chance you close the account that costs you the most money. That’s why the avalanche method earns the title as the money-saving option.
The Snowball Method
The snowball method, by contrast, organizes your list by outstanding balance with the intent to pay off the smallest balance first. Once you pay off this account, you roll your extra cash into the next smallest balance and so on until you wipe out all your debt.
Since the snowball method doesn’t consider interest, you may accrue more interest this way. This is especially true if you owe several high-interest lines of credit or cash advances.
The Psychology Behind the Snowball Method
On paper, the avalanche method sounds like the better deal. Since it eliminates the personal loan that earns the most interest first, you may accrue less interest overall. It’s an effective way to manage your debt.
Unfortunately, it may take a long time because high interest accounts tend to also have high balances.
According to a couple of studies, this timeframe may be an enormous obstacle. Few people have the patience to stick with the avalanche method. By contrast, research shows that people who adopt the snowball method are likelier to eliminate all their debt.
Why? Because the snowball method closes accounts faster than the avalanche method; an early win can be highly motivating for most borrowers. It has the biggest impact on your sense of progress, so you’re more likely to stick with a budget, even if you pay more in interest technically.
The Takeaway:
Logic says to choose the method that saves you money, but this victory may take too long for the average borrower. Counter intuitively, the method that allows more interest to accrue may encourage you to stick with your debt payment goal and be more successful.
Ultimately, the method you choose doesn’t matter if you stick with it. Consider your options now that you know the differences between these two main methods.
