Debt Avalanche –
- List your debts – from highest rate to lowest rate – and make minimum payments to all accounts.
- Make extra payments to the first account on the list, until it is paid-in-full.
- Combine amount (minimum payment and extra payment) which had been going to the first account on your list, and apply it to the second account on your list.
- Repeat this process until all accounts have been paid-in-full.
Pros –
- Mathematically sound
- Easy to setup, easy to follow
- Plan can include or exclude first mortgage
- Minimizes amount paid in interest
Cons –
- Having a large balance on top of your list can be discouraging
- Focusing primarily on one debt at a time could be discouraging
- Does not differentiate between secured and unsecured debt
Debt Snowball
- List your debts – from smallest balance to largest balance – and make minimum payments to all accounts.
- Make extra payments to the first account on the list, until it is paid-in-full.
- Combine amount (minimum payment and extra payment) which had been going to the first account on your list, and apply it to the second account on your list.
- Repeat this process until all accounts have been paid-in-full.
Pros –
- Paying off entire accounts, quickly, is emotionally satisfying
- Easy to setup, easy to follow
- Plan can include or exclude first mortgage
- Quickly eliminates smaller account balances
Cons –
- In most cases, isn’t the most mathematically sound method
- Focusing primarily on one debt at a time could be discouraging
- Does not differentiate between secured and unsecured debt
Focus On Multiple Debts
- List your debts and make all minimum payments.
- Decide and budget for a fixed monthly extra payment.
- Divide monthly extra payment by number of accounts.
- Send that amount to each account on your list.
- Continue to send extra payments to all accounts, until one account has been paid-in-full.
- Divide monthly extra payment by the remaining number of accounts.
- Sent that amount to each account remaining on your list.
- Continue this process until all accounts have been paid-in-full.
Pros –
- Allows you to focus on multiple accounts, instead of just one
- The fixed extra payment is included in your monthly budget as a budget item
- Plan can include or exclude first mortgage
- As you eliminate accounts, the amount going to the remaining account increases, thus providing a bit of a snowball effect.
Cons –
- Due to the fact that interest rates are not considered, this isn’t the most mathematically sound method.
- Lack of focus on one account could be discouraging
- Does not differentiate between secured and unsecured debt
- A disproportionate percentage of extra payments will go towards accounts with smaller balances
Focus On Specific Debt
- Follow either The Debt Snowball or The Debt Avalanche method, but instead of using balances or interest rates to determine the order of your accounts, prioritize your list based on your own personal desire to be rid of specific account balances.
Pros –
- Shifts focus to account at the top of your list, perhaps debt owed to the IRS or a personal loan owed to a friend
- The personal nature of this method may motivate you more than any other method
- Provides a sense of control over financial situation
Cons –
- This may not be the most mathematically sound method
- Easy to get off track after worrisome debt has been paid-in-full, due to lack of continued focus
Good Debt, Bad Debt
- Create two lists, one with good debt and one with bad debt. (Good debt and bad debt are subjective terms.)
- Use any of the methods listed above to rid yourself of bad debt, while paying minimum payments toward good debt.
- Once bad debt has been eliminated, choose to focus on good debt or choose to continue to make minimum payments and focus on retirement, education, or other savings.
Pros –
- Allows you to focus on debts with higher interest rates, unsecured debts, etc.
- Separating debts remove stress of focusing on entire debt balance
- By not focusing on mortgage debt (or other good debt), you are free to contribute more to retirement and education savings.
Cons –
- Determining which debts are good debt and which debts are bad debt can be subjective
- Debt is debt, and no matter the type, it must eventually be repaid
- By not focusing on certain types of debt, one might be lulled into a false sense of financial security
Other Tips For Reducing Debt
The following tips work with any of the above mentioned debt reduction methods –
- Make multiple extra payments each month, which will speed up your debt reduction progress.
- Carefully consider credit card balance transfers. Before making a transfer from one account to another, be sure that you fully understand the terms under which the transfer will be made.
- Change your spending habits. You do not want to become a debt reduction expert! Do this once – and then learn to live debt free!
- Read the article I recently wrote about The Debt Deluge – my attempt to combine the best of all debt reduction methods.
What about you? Do you have a method that I haven’t covered here? Are you using one of the methods listed above? Any tips and techniques you would like to share?
A special note to my fellow bloggers - If you have written an article about one of the methods above, and you’d like to share it with my readers, please contact me an let me know. Please refrain from linking directly to the article in the comments section. If I think the article is pertinent, I’ll be glad to share it with my readers. Rock on.
I personally prefer the debt snowball – know the small ones one to focus on less accounts… I just have $700 left on a Visa, then I’m debt free! (except for the house)
Really, you do it anyway you want, just DO IT!
Not to be repetitive, but since this is similar to the last post here, my previous comment will apply here as well:
I happened to come up with a more specific plan of action a few weeks ago in a post called Try Taking A Different Approach to Paying Down Debt .
While it may be a psychological advantage to list debt in order of balance or interest rate, there is one important aspect that both theories fail to address: the overall effect of interest on a balance. By taking an extended look at one’s debt, they can see which debts are truly costing them more in terms of compounding interest as time goes on. Sometimes a mid-level balance combined with a mid-level interest rate will end up incurring higher interest charges going forward than any of the other debt obligations depending on the situations.
I think it is too simple to pay down debt based on surface numbers, such as balance or interest rate, even though it is easier to see the effects of the effort. People would be better off eliminating the debt which is costing the most in additional interest first, which will minimize the the additional interest charges being applied going forward.
We do the debt snowball here. We need the emotional tie to actually seeing what is getting paid and making progress. We tried the highest percentage first, but it just wasn’t motivating enough.
Cash is King now for us and will be our main priority.
I prefer the avalanche method, but see the value in the snowball. Paying off a low balance card is a great feeling.
I currently have a townhouse on the market and hope to upgrade to a slightly bigger home this year. I currently have cc debt that I have been snowballing – the rate is 2.9%. Should I boost up my savings or continue to attack the cc debt to be better positioned for a better mortgage rate??
Hey thanks for the list. While I know about these already it’s good to have it in one location for a handy list 🙂
This is my favorite site, because becoming debt free is the KEY to financial stability. All else comes second.
I prefer the snowball, because it eliminates both a liability, a monthly expense, and a bill to track all in one swoop.
I also think the best method is the one that will most likely keep you motivated.
I firmly believe that mathematics, balances, interest rates, etc don’t matter. Motivation matters. Whatever motivates you is what you shoud do. People are motivated by goals, dreams, fear, etc.
Interest rate, balance, monthly payment, debt discomfort, etc. There are numeros ways to list the payoff order. What I have found is it doesn’t really matter which order. It matters that you start, and you finish.
Thanks for an interesting post. All the best.
Great list! I think it depends on what kind/how much debt you have to figure out what works best. I only have a student loan and a car loan…the student loan has a higher balance but a lower rate, but I’d rather pay the car off quicker. 🙂
I like the chunks method. I pay down chunks of money on my debt when I feel like I have a little extra. I think one of the big things that stinks about debt is the burden that it has in your mind. When you are feeling good about your money situation, that’s when it feels good to chunk down some debt. I’ve been paying 400 nearly every month on a Credit Card that has a balance of 4,000. Something about paying down 400 bucks on $4,000 feels good. Its a good number for me.
I paid off my student loans last year as one of my goals for 2008. I think the feeling of knowing its gone is bigger then the actual savings on interest
Still chipping at that credit card which is at 0% until June….but Hawaii was worth a little debt…
I would opt for the credit avalanche. Pay off those high interest debts first. If you have borrowed money at 3 or 4%, that’s a positive thing. Or, if you can, take a bank loan and pay off all of your debts that are at a higher interest rate than the bank loan.
We follow the snowball. Your list gives people a complete understanding. Useful post.
Regards
One unappreciated benefit of the debt snowball is that it decreases your risk (for example, in case of a layoff) by reducing your monthly burn rate (of minimum payments). If your debt reduction plan is disrupted, you are (temporarily) in a much better position if you need lower cash flow to make it through the period of disruption. Long term you are better off paying the highest rate first, but you may be carrying higher risk by doing so.
The debt avalanche is a very good method, my sister uses the avalanche and swears by it. Because, though it takes more patience and resolve, in the end it is faster and you save money. This was an informative article I really enjoyed it. However, I think that if people are buried under considerable debt they should think about consulting professionals. Institutions like CareOne and Jubilee Worldwide have had years of experience helping people get out of debt, and I think I would take advantage of their expertise. I have heard great things about these companies you should check them out.