If you’re like most Americans – about 80% of all Americans, according to The Pew Charitable Trusts – you have some form of debt. And chances are, you already know what you need to do to pay off that debt: either cut your expenses, or find some way to earn more money. Then you can just take all that extra cash and use it to make extra payments on your debt, and keep doing it until the debt is gone.
But it starts to get tricky when you have several different debts to pay off. If you have a student loan, a car loan, and two credit cards all clamoring for repayment, putting a tiny bit of extra cash toward each one won’t get any of them paid off very quickly. To make a real dent in your debt, you’d like to put all your extra money toward just one of them, pay it off, and move on to the next. The question is, which one should you tackle first?
Financial experts have several different answers to that question. Some argue that it’s best to focus on your smallest debt first to give yourself some momentum. Others say it’s best to work on the debt with the highest rate of interest because you’ll save the most money overall. And if money is tight, you can apply what you can, whenever you can, to shave away the debts until they are finally repaid. All of these approaches can work, but each one has its own specific set of advantages and disadvantages.
1. The Debt Snowball Method
Imagine you’re building a snowman, and you need a big snowball to form the base. The easiest way to do this is to pack a small snowball and roll it along the ground, picking up more and more snow as you go. By the time you get across the yard, your tiny snowball has turned into a massive snow boulder.
The snowball method of debt repayment works much the same way. You start by paying off your smallest debt as quickly as you can. As soon as that debt is gone, you take all the money you’ve been paying on it and add it to the payments of the next-smallest debt. As one debt after another gets paid off, you keep adding more and more “snow” to your payments, until you have one big payment each month going toward your final, largest debt.
How a Debt Snowball Works
Suppose you have four different debts you need to pay off:
- A MasterCard with a balance of $700 and an interest rate of 18%. Monthly minimum payment: $17.50
- A Visa card with a much higher balance of $3,000 and an interest rate of 25%. Monthly minimum payment: $92.50
- A 10-year, $8,000 student loan at 5% interest. Monthly minimum payment: $85
- A 5-year, $10,000 car loan at 8% interest. Monthly minimum payment: $203
As the minimum payment calculator at Bankrate shows, if you do nothing but make the minimum payment each month – and you charge nothing else in the meantime – it will take you more than six years just to pay off your smallest debt, the MasterCard. The much larger Visa bill will stick with you for nearly 20 years.
The other two loans, which have fixed monthly payments (though you’re free to make larger payments) will shrink at a steady rate – but it will still take five long, discouraging years just to pay off the car loan. And when that’s gone, you’ll still have three debts remaining, with years of payments ahead of you.
Now suppose you’ve managed, by pinching pennies, to save up an extra $100 a month. By following the debt snowball method, you throw that entire $100 at your smallest balance – the MasterCard – on top of the minimum payment you’re already making. Meanwhile, you continue to make the monthly minimum payments on all your other debts. Over time, the minimum payments on your credit cards may drop; however, you ignore that and keep paying at a steady rate.
According to the debt snowball calculator at Dinkytown.net, doing this will eliminate your MasterCard debt in just seven months. As soon as it’s gone, you can take the total amount you were putting toward it – $117.50 a month – and apply it to your Visa bill. That boosts your monthly Visa payment to $210, allowing you to pay off the balance in less than two years.
Once you pay off the balance on the Visa, you can take the $210 you were paying and apply it to your student loan, boosting your monthly payment to $295. At that rate, you’ll have that 10-year loan paid off in just under four years. At this point, you can bump up your car loan payment to a whopping $498, polishing it off in four years and four months – all with just an extra $100 a month.
Pros and Cons of the Debt Snowball
One of the biggest boosters of the debt snowball method is financial expert Dave Ramsey. He argues that wiping out your smallest debt quickly gives you an immediate morale boost, encouraging you to keep hacking away at the bigger debts. Because you can actually see your debts disappearing, you’re more likely to stay motivated and stick to your debt payment plan.
However, while the debt snowball method quickly reduces the number of debts you owe, it’s not the fastest way to reduce the total amount of debt you owe. Because you focus on the size of the debt rather than the interest rate, you may end up holding on to high-interest debt longer – which means that you end up paying more interest in total. And paying a larger amount, in turn, means that it can take you longer to become completely debt-free.
One way to get around this problem is to look for ways to refinance your high-interest debts. For example, you might be able to transfer all or some of that $3,000 Visa balance to the lower-interest MasterCard. If you transfer $2,000 to the MasterCard, then that will make the remaining $1,000 on your Visa the smallest debt and the one with the highest interest rate. That makes paying it off first a win-win.
The catch with using a balance transfer is that most banks charge a fee for it – often 3% (and sometimes as high as 4%) of the amount being transferred. So in the example above, transferring $2,000 to your MasterCard would cost you a one-time fee of $60. But transferring the balance will save you about $12 in interest each month, so you’ll come out ahead after the first five months. You can use a balance transfer calculator like the one at CreditCards.com to determine whether a balance transfer makes sense for you.
Another option is a debt consolidation loan. This means taking out a new loan, using that money to pay off your old high-interest debts, and then paying off the new loan. For instance, you might be able to pay off the $3,000 Visa balance and the $700 MasterCard balance with a new five-year loan at 12% interest. This new loan would still be your smallest one, so you’d focus on it first – but you’d be paying much less interest on it, so you’d be able to pay it off much faster with the same monthly payment.
Keep in mind that a debt consolidation loan you take out on your own is not the same thing as a debt management plan (DMP). A DMP is a third-party program that deals with your creditors on your behalf, often negotiating lower interest rates and making all the payments for you. Using a DMP usually requires canceling your old credit cards, which damages your credit score, and can have other negative credit implications as well. So if you already have a plan to pay off your debt without any help, using a DMP is not a good option.
2. The Debt Avalanche Method
When an avalanche strikes in the mountains, it starts at the highest peak and spills downward. The debt avalanche method – also known as “debt stacking” – takes a similar approach. Instead of starting with your smallest debt and gradually working your way up, you start at the peak of your debt mountain: the account with the highest interest rate. Once that’s paid off, you move on to the account with the next-highest interest rate, and so on from there.
The basic idea behind the avalanche method is the same as the snowball method: Once you pay off one debt, you put the amount of that debt payment toward the next debt. However, because you’re starting with your most costly debt, every payment saves you more money and gets you closer to being debt-free.
How a Debt Avalanche Works
To see how a debt avalanche compares to a debt snowball, let’s go back to our earlier example. You still have four different debts – two credit cards, a car loan, and a student loan – that cost you a total of $398 in payments each month. And you still have an extra $100 per month that you can put toward any one of these debts.
With the debt avalanche, that extra $100 is applied to your highest-interest loan: the $3,000 Visa bill. You continue to make low minimum payments on your other loans. By doing this, you can pay off the Visa bill in about 20 months. With that high-interest loan gone, you can focus on the MasterCard bill and pay it off in just a couple of months. Then you attack the car loan, and finally the student loan.
With this payment schedule, it takes roughly the same amount of time to become debt free as it does with the debt snowball method. However, the total amount of interest you pay during that time drops from $4,074 to $3,823. So all told, you come out $250 richer if you use the debt avalanche method.
The more high-interest debts you have, the more you gain from choosing a debt avalanche rather than a debt snowball. For example, if your high-interest Visa bill were $9,000 instead of $3,000, and you still had only $100 extra to spend each month, it would take you four-and-a-half years to become debt free with the snowball method. During that time, you’d pay more than $9,164 in interest. With the debt avalanche, by contrast, you’d pay $7,062 in interest – a savings of more than $2,000 – and you’d be out of debt three months earlier.
Pros and Cons of the Debt Avalanche
In strict mathematical terms, a debt avalanche is definitely a better deal than a debt snowball. It saves you more money, and it can even get you out of debt faster. After all, an investment with a guaranteed return of 25% would be an unbeatable deal – and that’s exactly what you get by paying off a debt with a 25% interest rate.
However, if you don’t have a lot of high-interest debt, the debt avalanche method isn’t that much faster than the snowball method. It still saves you money, but only if you stick to the plan – which can be difficult if you’re not seeing any progress. With a debt avalanche, it often takes a long time to pay off your first debt, which leads some people to become discouraged and give up. Even personal finance columnist Liz Weston, who generally favors going after your “toxic” high-interest debts first, admits that a debt snowball can work better for people who need some small victories early on to stay motivated.
One way to combine the financial benefits of the debt avalanche with the psychological perks of the debt snowball is to track your progress as you pay down debt. There are many free calculators, spreadsheets, apps, and other debt-tracking tools online that you can use to watch your debt shrink from month to month, such as ReadyForZero.
You can also do this the old-fashioned way, with a piece of graph paper and a colored pen. Draw a bar for each of your debts, with one square for each $100. As you pay down the debt, you can color in these boxes, so you can watch your progress toward your goal. Either way, just being able to see how much of a dent you’ve made in your debt can give you the morale boost you need to keep going.
3. The Debt Snowflaking Method
Both the debt snowball and the debt avalanche depend on finding extra money in your household budget that you can regularly apply to your debts. But when you’re really strapped for cash, squeezing out an extra $100 per month isn’t always possible.
Still, many people occasionally receive a little financial windfall – a tax refund, proceeds from eBay sales, or just a $5 bill discovered in a jacket pocket. With debt snowflaking, you take all these little sums and put them toward paying down your debt. Each individual sum is tiny, just like a snowflake – too small to have much effect all by itself. But just as little snowflakes can add up to a big pile over time, these little sums add up to make a big impact on your finances.
How Debt Snowflaking Works
Let’s take a look at our example one more time. You have four debts that add up to $21,700, and you have enough money in your budget to meet the $398 total minimum payments on these debts. However, you just can’t find the money to make extra payments every month.
In this situation, you can still use the debt snowball or the debt avalanche methods in a very limited way. That is, when you finish paying off one debt, you can apply the money from that payment to the next debt. But with no extra money to budget toward repayment, you’ll take about six years to pay them all off.
But now suppose that during the first week of following this plan, you make $30 babysitting for a friend. Instead of spending that money, you use it to make an extra payment on your smallest debt – the MasterCard bill. The second week, you get a $15 rebate check for a purchase you made, so you put that toward the MasterCard as well.
During the third and fourth weeks, you shop at several good sales at the grocery store. Your monthly budget for groceries is $300, but at the end of the month, you find that you only spent $260. That leaves you with an extra $40, so it goes toward the MasterCard debt too.
Each of these little savings, or “snowflakes,” is not very big. But by applying them all toward one debt, you’ve managed to shrink that debt by an extra $85 in just one month. If you can continue to find similar savings every month, you can pay off all your debts in less than five years – almost as fast as if you’d been putting a steady $100 a month into a debt snowball.
Of course, you can’t count on being able to find $85 in savings every month. Some months, your little snowflakes might add up to only $50, or $20, or nothing at all. But during other months, you’ll have bigger windfalls, such as $250 in overtime pay or $200 from a successful garage sale. As long as you keep putting these bonuses toward your debt, they’re bound to add up to significant savings in the long run.
Pros and Cons of Debt Snowflaking
The main benefit of debt snowflaking is that you can use it even if you’re on a tight budget. You don’t have to cut your expenses or shortchange your retirement savings – you can just use whatever small, unexpected sums come your way.
There’s also a psychological benefit: The snowflake sums you put toward your debt are usually so small that you won’t miss them much. For many people, paying $10 here and $20 there is a lot less painful than parting with a $100 lump sum every month. At today’s prices, an extra $10 in your pocket isn’t enough for dinner and a movie – but a bunch of little $10 payments are enough to make a significant impact on your debt.
The biggest downside of the snowflake method is that the results aren’t guaranteed. When you set aside an extra $100 every month like clockwork, you know exactly how fast those extra payments are going to shrink your debt. With snowflaking, you must rely on whatever comes along, so your progress toward becoming debt-free isn’t steady.
A final problem with debt snowflaking is that with some loans, there’s no way to make tiny payments throughout the month. Some lenders won’t process more than one payment in a month, and others charge a fee for processing extra payments. If you’re dealing with a lender like this, your best bet is to save up all your little snowflakes in a safe place – like a change jar or a savings account – and add them in a lump to your regular monthly payment.
Combining Debt Snowflaking With Other Methods
Another nice thing about debt snowflaking is that you can combine it with either the debt snowball or the debt avalanche method. For instance, you could set aside a fixed $50 per month to make extra payments on either your smallest debt (a debt snowball) or your highest-interest debt (a debt avalanche). Then, throughout the month, you can throw in your snowflake payments on top of that, so you can reach your payoff date even faster.
Doing this gives you the best of both worlds. Your regular $50 payment gives you the satisfaction of making slow, steady progress toward your goal – even during months when you have no snowflakes to add to it. But when you do make extra payments, you can see your steady progress punctuated by leaps and bounds that bring you closer to your goal. In this way, your snowflake payments become a special bonus – not something you have to rely on.
Saving Your Snowflakes
Just like snowflakes, tiny sums of money have a way of disappearing quickly. If you discover a $5 bill in your pocket, it’s tempting to treat yourself to a latte, which gives you instant gratification. Squirreling the $5 away to put toward your debt doesn’t feel nearly as satisfying, especially since it’s such a small sum that you won’t see a major impact from it.
One way to get around this problem is to find ways of tricking yourself into setting money aside. For example, you can keep a jar on your dresser to stash all the small sums you earned or saved that day, such as the dollar you saved by not ordering a drink with your lunch. If this extra money isn’t in your wallet, you can’t spend it. At the end of the week, you can empty out the jar, deposit the contents into your bank account, and use that sum as a snowflake payment.
Another trick that works for some people is to carry a “snowflake card” for motivation. For example, if you save $3 by walking to work instead of taking the bus, immediately write down “$3 – bus fare” on an index card and stick it in your wallet. Each time you add a sum to your card, it gives you a little burst of satisfaction that makes saving almost as enjoyable as spending.
When it comes to debt, the most important thing isn’t how you pay it off – it’s actually doing it. So the best method to choose is the one that you know you’ll stick to. If the thing that motivates you most is seeing your debt shrink as quickly as possible, you’re better off with a debt avalanche. It’s the best choice for left-brained, numbers-based people because it saves you more money in interest payments and gets you out of debt faster.
On the other hand, if you get a big morale boost from seeing a debt vanish completely, you’re a good candidate for the debt snowball. This method works well for right-brained, emotional people who need short-term victories to keep them going. No matter which method you choose, you can use debt snowflaking to chip away at your debt even more, shortening your payoff time.
It’s also possible to combine the two methods to get the benefits of each one. If you have several small debts, you can tackle the highest-interest one first before moving on to the others. Because it’s a small debt, you still get a quick reward, and you also get the savings that come with paying off a high-interest debt.
Another great thing about the debt snowball and the debt avalanche is that they can keep working for you even when all your debts are gone. Once you pay off the last debt, you can just take the monthly sum you’ve been spending on debt payments and start putting it into low-risk investments instead. That way, instead of watching your debt shrink each month, you can watch your nest egg grow – an even more rewarding experience.
Which method of paying off debt do you prefer? What do you like about it?