Debt Snowball vs The Debt Avalanche

I get asked a lot how should I prioritize paying off my debt. There are two main methods that are talked about on debt payoff. One option is to pay off the lowest balance debt first, this is called the debt snowball, made popular by Dave Ramsey. The other focuses your paying off of the debt with the highest interest rate first. This is sometimes called the debt avalanche. Both options have some pros and cons so what is the best option for you to pay off your debt? Lets dive in.

The debt snowball is taking the smallest balance of all your debts and paying that off first. For example, if you have four different kinds of debt that total $20,000 but they are different amounts such as $1,000, $4,000, $10,000 and $5,000 you would pay aggressively on the $1,000 debt regardless of the interest rate. Then, once you pay off the small debt you use the extra money you were paying on that debt and put more on the next smallest debt. Therefore creating a “snowball” effect as you can keep adding to the amount you are paying as you pay each debt off.

The debt avalanche in that situation would not care about how much you have on the balance of each debt it would strictly look at the interest rate and so that method would pay off the one with the highest interest rate first regardless of how much debt you have at various interest rates. If the four previous debts listed above have interest rates of 7%, 3%, 10% and 4% you would put your focus on the debt with the 10% interest rate.

These two methods are effective for paying off debt. If you follow either strategy all the way through with focus you will pay off your debt. The question is which one is better? The debt snowball is a fantastic way to get momentum for when you start your debt payoff. It runs off psychology versus math. If we look back at our previous example you would take the $1000 debt and put everything you possibly can on that and pay it off first even though it does not have the highest interest rate. Why? Because you feel progress. It's amazing how motivated you'll be once you feel some progress and that is the whole key to the debt snowball. So, if you know that a quick win will give you extra motivation, the debt snowball is for you.

Analytical types will have a hard time not paying extra on the high-interest rate debt because that is costing you more money. If this is you, you may be drawn to the debt avalanche. When looking at our previous example you would put all the extra money you can find on the 10% interest rate debt. Mathematically this one works well and you will save the most money on interest doing it this way if you can pay it off quickly. The problem comes if the biggest debt you have has the biggest interest rate it takes a long time to see progress. And your motivation might not be as strong therefore, it could take you longer to get out of debt. Sadly, that is the most common thing.

Whatever option you chose, stay focused! In my opinion, paying off debt is much more of a mental exercise than a math exercise. If you want to get out of debt quickly, you need to run as fast as you can and getting quick wins will help you along the process. That’s why I am in favor of the debt snowball method, however, either can get you to your goal. Getting out takes a lot of hard work, there is no shortcut. Stick to your budget, stay focused and you can do it!

Phil Francois, CFP®
Owner & Financial Advisor
Foundation Wealth Planning
www.foundationwealthplanning.com