When you’re working on paying off debt, you may be confused on where to start. You have multiple debts with varying balances and interest rates. How do you know which one to pay off first?! Well you’re in luck! There are two methods used to paying off debt that people use to kick debt quickly. Both have pros and cons, but they ultimately achieve the same goal: to pay off debt!
The Debt Snowball
Made famous by financial guru Dave Ramsey, the debt snowball helps people to get debt free quickly by celebrating small wins and building momentum. This method has you list out your debts and organize them by their balances from smallest to largest and pay them off in that order. An example would look like this:
Once you have all your debts listed smallest to largest balance, it’s time to start tackling the top loan and get it to zero as soon as possible! Make minimum payments to all your loans and throw any extra cash you have to that smallest debt. In this case, all our minimum payments total $720 each month. If you can budget to pay $1,000 to debts each month, then the extra $280 goes to that 1st student loan. Each month you’ll see that smaller debt get smaller and smaller and then get to zero!
Once you’re done with the first student loan, it’s time to start on the credit card! You’ll then take that extra $280 plus the $75 student loan minimum payment to apply an extra $355 to the credit card. This method is applied all the way down the line until you’re left with paying $1,000 a month to your second student loan. By paying $1,000 to that last loan, you’ll be done sooner than you think!
The debt snowball is great because you build momentum and it helps you psychologically to stay focused. That first small debt will be paid off quickly and it’s encouraging to cross that entire loan off your list! This is a great method to use if you don’t know much about personal finance. This is a pretty basic method that will encourage you to continue on your financial freedom journey!
While this method helps you build momentum and encourages you to become debt free, it isn’t as mathematically beneficial as the debt avalanche.
The Debt Avalanche
The debt avalanche is an additional method to pay off debt quickly and orderly. This method has you list all your debts by interest rate high to low and pay them off in that order. The example we used in the debt snowball would look like this in the debt avalanche:
Just like we talked about in the first example, you will want to tackle that top loan with the highest interest rate and get it done as soon as possible! You would pay minimums on all loans, but throw any extra cash at that credit card. Again in this case, all our minimum payments total $720 each month. If you can budget to pay $1,000 to debts each month, then the extra $280 goes to that credit card.
Once you’re done with the credit card, it’s time to start on the 2nd student loan! You’ll then take that extra $280 plus the $125 credit card minimum payment to apply an extra $405 to the 2nd student loan. This method is applied all the way down the line until you’re left with paying $1,000 a month to your car loan.
The best part about this method is the lessor amount of interest you will pay. By paying off high interest loans first, you’re giving it less time and a smaller principle so that interest won’t accrue as much as it would in the debt snowball. This method makes more sense mathematically and financially with you saving more money.
The down side to this method is that you might not feel as motivated and encouraged to continue. When you’re in the middle of that $15,000 loan, it’s going to be hard. It’s going to be long and tedious and you won’t have that satisfaction of crossing that loan off your list for a while.
But if you understand personal finance and are able to still push yourself to keep going, then I recommend using the debt avalanche because of the lessor amount of interest you pay. You just will have to set small goals for yourself. Celebrate with ice cream for every $5,000 you pay off rather than when that next loan is complete. My husband and I are mathematically minded and like to use this method, and we celebrate when we hit another $10,000 mark of debt payoff. It keeps us motivated to keep going and is also a relief that we’re saving a little bit of money in interest.
Whatever method you choose, you are making the smart choice to pay off your debts! No choice is wrong or right. Choose the one that will ultimately keep you motivated to continue on your financial journey to get out of debt, save, and build wealth!