Snowball vs Avalanche w/Example

Do you snowball or avalanche? Are you aware of these terms? These are two different ways to tackle your debt accounts.

First, list all of your debts including total, interest rates, and minimum payments. Once you have this list, there are two contending strategies that exist to help you pay these down. Which one you choose will depend on your personality and your motivation levels. The debt snowball method attacks your smallest balances first (benefit of celebrating successes earlier), and the debt avalanche goes after the higher interest accounts first (benefit of saving on interest charged). 

Before you choose, you need to determine your cash flow. This is where a budget comes in handy. Once you create a monthly budget, and determine where you'll allocate your money, hopefully you have a positive balance at the end of the month. If not, this definitely deserves your attention. You need to stop going in to debt before you can begin paying down your debt, obviously.

Once you determine your cash flow, it's best to throw as much of this money as possible at your debt accounts. With the snowball method, you pay the minimum payment on all accounts except for the account with the smallest balance. This account gets the minimum plus your extra cash flow dedicated to debt repayment. Once that balance is paid off, you roll that payment total into the next account with the smallest balance (the other accounts still getting minimum payments), and so on, until all accounts are paid off. 

The debt avalanche method works the same way, you simply dedicate all your debt repayment money towards the account with the higher interest rate, working your way down from there until all accounts are paid off. 

Example:

Let's say you have 3 credit cards. Current statistics suggest the average American has around $15k in credit card debt. So, I'll use that total. It breaks down like this:

1. Balance = $9000, min payment = $160, interest = 21%
2. Balance = $4000, min payment = $50, interest = 9%
3. Balance = $2000, min payment = $30, interest = 15%

With the snowball method, you'll pay accounts in the order of #3, #2, #1.

With the avalanche method, you'll pay accounts in the order of #1, #3, #2.

Minimum payments add up to $240. Let's say you free up 300 extra dollars each month to put towards debt. So your total payment each month is starting at $540 (the following calculations assume your finances stay the same, or you don't dedicate more money over time to debt repayment). Once one account is paid off, roll that payment from the dead account into the next account. 

Using this calculator, it gives us some valuable information. The avalanche method will pay off the total debt 2 months earlier (35 months vs 37 months), and will save you $1200 in total interest. The snowball method, however, will help you feel "success" earlier because you'll pay off your first account in 7 months vs 25 months. While avalanche makes financial sense, think of that snowball benefit. In 7 months you'll see your first account paid off completely, compared to over two years using the avalanche method. This proves powerful to many in terms of keeping motivated.

Here's another calculation. Continuing to make minimum payments only on all accounts will take 179 months to pay off completely. That $15k will cost you over $27k in interest to pay off.

I've determined that I'm in this for the long haul, and while I know personally the snowball method would work best for me, I'm thinking the spreadsheet and graphs I've created will help me measure enough success over time to stick with the avalanche method and take the financial benefits.

Happy Monday.