Getting out of debt is something we all want to happen sooner rather than later. Debt reduction should be one of the first steps we take on the road to financial freedom. I am going to look at the two most popular debt reduction methods out there.
The two methods I am talking about is the Debt Snowball and the Debt Avalanche. These methods are commonly suggested as a way to reduce revolving credit like credit cards, personal loans and store cards.
The Debt Snowball strategy gets you on top of your debt by paying the minimum on all your debts and putting any extra money towards paying off the smallest balance first. Once the smallest balance is paid, take the payment that you were putting towards that small balance and add it to the payment of the next biggest balance. Repeat this while working up to your largest balance. As you work through the balances the payments towards the smallest balance will get larger and larger, Just like a snowball rolling down a hill gathering more snow.
- List all your debt balances from smallest to largest
- Ensure you pay the minimum on all debts
- Work out how much extra you can pay and put it towards the smallest balance in addition to the minimum
- Once the smallest balance is paid off, take that money and add it to the next largest balance.
- Rinse and repeat.
The debt Avalanche is very similar, make the minimum payments on each balance. Put the extra money towards the debt with the highest interest rate. Now that this is eliminated move to the next highest interest rate. Continue this until debt freedom.
The main advantage to this method is that you will save the most on interest payments, therefore paying off your debt as fast as possible.
Things to consider when choosing the debt to pay first
- two debts with similar rates – pick the lower balance
- consider early payment fees and charges
- consider liquidity – if you make a payment on a card you can still get access to the money, if its a car loan maybe not.
- tax deductions may affect the real cost of the loan and should be considered.
- other related savings due to removing the debt – savings on insurance, card fees etc…
The Debt Snowball aims towards the psychology of getting early wins to keep you motivated and on task. If you are prone to giving up and need the motivation this could be for you.
The Debt Avalanche concentrates on the fastest route to becoming debt free saving the most money. If you have the resilience of a rock, the Avalanche may be the best option.
Blending the two popular debt reduction methods can also be a good choice. Get rid of that pesky little balance first then concentrate on the beastly one with the high interest. Please let me know if you have your own method for tackling debt.