Debt Reduction

Debt Deluge – Modified Debt Snowball

I am a big fan of  Dave Ramsey.  I listen to his radio program and I’ve read all of Dave’s Books. His is one of my favorite personal finance books.  Dave made famous a specific debt reduction method – The Debt Snowball.  From personal experience, I can verify that The Debt Snowball works – and I’ll be eternally grateful for Dave’s enthusiasm about debt reduction.

The Debt Snowball –

  • List your debts – from lowest balance to highest balance – and make minimum payments to all accounts.
  • Make an extra payment to the first account on your list.
  • After paying off the first account, take the combined amount (minimum payment and extra payment) which had been going to the first account, and apply it to the second account.
  • Repeat until all of your accounts have been paid off. and your debt has been eliminated.

There is one major issue with The Debt Snowball that cannot be ignored.  Dave suggests paying debts off in order of account balances, focusing on the smallest balance first.  By ignoring interest rates, Dave’s plan, on paper at least, could actually cost more than alternative methods.

Clearly, the goal of The Debt Snowball is to help us get out of debt.  In the long run, this saves money.  Dave’s theory – and one that has held up over time, despite criticisms – is that there are emotional and psychological benefits associated with paying off an entire account balance.  Once that first account is paid off, the fact that it is paid off motivates us to attack the second account, and so on, until all accounts have been paid off.

Personally, I like Dave’s plan, but I do realize it’s flaw.  By not taking into account interest rates, The Debt Snowball could leave you with a big debt, and a higher interest rate, for much longer than necessary.  Imagine this scenario.

  • Debt A – $900 @ 8.9%
  • Debt B – $1,700 @ 3.9%
  • Debt C – $5,000 @ 6.9%
  • Debt D – $10,000 @ 4.9%
  • Debt E – $12,000 @ 19.9%

Under Dave’s plan, you would focus on debts A, B, C, and D, first, even though Debt E has a dramatically higher interest rate.  Allowing an account with such a high rate to just hang around, while you focus on the accounts with smaller balances, could get frustrating.

An alternative method of debt reduction,The Debt Avalanche (so coined by my good friend Flexo from Consumerism Commentary), suggests that we ignore account balances, and instead focus on interest rates.  The same “snowball” technique applies, paying minimums and rolling old payments into new accounts, but our accounts are listed from highest rate to lowest rate.  Our scenario, under The Debt Avalanche would look like this.

  • Debt E – $12,000 @ 19.9%
  • Debt A – $900 @ 8.9%
  • Debt C – $5,000 @ 6.9%
  • Debt D – $10,000 @ 4.9%
  • Debt B – $1,700 @ 3.9%

Under The Debt Avalanche plan, we’re now focusing on the account with the highest interest rate – and we’re following a mathematically sound approach.  There could be, however, for some folks, a problem with this plan –

Watching a $12,000 balance drop to $11,100 just doesn’t feel as good as watching a $900 balance drop to $0.

Face it, we are emotional creatures, and there’s something awesome about destroying an entire debt – even if the process does not add up mathematically.  I’m 99% sure that this is why Dave sticks with The Debt Snowball, instead of going with the mathematically-sound Debt Avalanche.  He knows that most people, most average people, need to feel the psychological impact of paying off an entire account.

The question is, can we combine the two, The Debt Snowball and The Debt Avalanche, and come up with something else – a Debt Deluge if you will – that will give us both the psychological boost of one and the mathematical advantage of the other?  Here’s my attempt.

Debt Deluge –

  • List your debts – from lowest balance to highest balance.
  • Draw a line at (or near) the midpoint of you list.
  • Reorder the debts that are below the line – from highest rate to lowest rate.
  • Make minimum payments to all accounts on the list.
  • Make an extra payment to the first account on your list.
  • After paying off the first account, take the combined amount (minimum payment and extra payment) which had been going to the first account, and apply it to the second account.
  • Repeat until all of your accounts have been paid off. and your debt has been eliminated.

The Debt Deluge is really just a combination of the two other methods.  When you start your debt reduction journey, you’ll begin by eliminating those small, pesky account balances.  As you move forward, and start to get used to the process, you’ll shift away from the Snowball and toward the Avalanche.  Our scenario now looks like this.

  • Debt A – $900 @ 8.9%
  • Debt B – $1,700 @ 3.9%
  • —————————–
  • Debt E – $12,000 @ 19.9%
  • Debt C – $5,000 @ 6.9%
  • Debt D – $10,000 @4.9%

Using The Debt Deluge, we can find a good balance.  Personally, I think it’s important to get rid of those smaller balances, as quickly as possible, but I don’t like the idea of leaving (too much) money on the table.  The Debt Deluge gets us started, and feeling great about eliminating those first few accounts, and then it prepares us for the long-haul, and dealing with those higher interest rates.  In the beginning, we sacrifice just a bit, and pay a little more in finance charges, for the psychological impact of paying off an entire account.  As we move forward, however, we move away from that technique, and towards a technique that saves more money, albeit at the cost of fewer psychological boosts.

What do you think?  Do you need the emotional boost of paying off those smaller balances, or are you content knowing that your plan is mathematically sound?  If we combine the two approches, do we get just enough of both worlds to push us forward?  I’d love to hear what you think about The Debt Deluge.

35 thoughts on “Debt Deluge – Modified Debt Snowball

  1. I like this method, and I think it’s something that would work for me. I’m trying to save money while paying off debt, but I like the psychological benefits of getting rid of a balance. This is a good idea! 🙂

  2. Well, its like Dave says, if we were doing math, we wouldn’t be in this mess in the first place. I always recommend paying off the lowest amount first. I’m a nerd and I thought about the math too, but really, this stuff is more psychological than mathematical. Get some traction, pay off the small ones and keep knocking them out. Save the big amounts until last.

    I would give this advice to everyone. I would say that most people who have a lot of debt accounts don’t even know the interest rate. It much easier to just say, pay off the lowest amount – even if its zero interest, your freeing yourself from one debtor that much faster.

  3. I think you make a good point about the psychological benefits of paying off small debts completely early in the process, to keep up motivation. My problem (if you want to call it that) is that I have no small debts. I just have two big debts — student loan and mortgage. No credit card debt, etc.

    I know that may be an enviable position to be in by some, and I am not complaining. But even though I throw extra money each month to the student loan it doesn’t seem to shrink. Well, that’s not true. It does, but when you compare a large number to a slightly smaller large number, it just doesn’t seem that different.

    Any suggestions for motivation in a situation like this? Right now the solution I have come up with, which works OK but I think could be improved, is to just not think about it. I have set up an automatic payment for the student loan which overpays each month, and have gotten used to not having that extra money around. Is that the best I can do — put it on autopilot so lack of motivation is not a problem?

  4. I like the idea of taking a sound plan and modifying it to meet you needs. Great tips thank you.

  5. First off, @ Taylor…

    I would suggest that instead of just looking at the previous balance and new balance each month, you track your balance over a long period of time and keep adding the new balance each month. I find Excel to be helpful in doing this for myself. Instead of seeing a drop of, lets say, $400 in your balance from month to month, you actually can see a steady drop as you pay month to month. This method works well with me because I am a visual learner.

    Now to address the blog…

    I believe how you order your debt repayment depends on the interest rates. In my situation have 8 total debts (including my mortgage) that total about $240K. The interest rates, however, only range from 4% to 8%, so no matter what the order of repayment is I am not effected that much. In fact, I have actually done the numbers and the snowball plan and avalanche plan is only about $3000 difference in the total amount of repayment–which is less than 1%.

    I do actually use the avalanche plan with one change to the rule though. I always have my mortgage as my last debt to be repaid in-full. Here’s why… When you make a payment, not only does your balance go down on your mortgage, but your equity also goes up. So if you make a payment of $1000 your equity may go up $500–a difference of $1500.

    That sums up my comment.

  6. I totally agree, I would much rather make an amount go to zero if I can than knock off a small percentage of something larger. It is more the mental aspect that when we do pay of something, we feel a sense of accomplishment. It’s crazy how the psychological weights play a huge role in people and their finances.

    I hear everyone talk about Dave Ramsey, I need to check him out a little more. Thanks NCN.

  7. I agree with Dustin. If you were doing the Math in the first place, you would not be in the mess. The debt snowball worked for me and it is what I recommend to everyone. Personal finance is 80% behavior and 20% head knowledge as Dave says. Kicking the habit and getting fired up about getting out of debt is how to do it.

  8. I don’t know, the reward psychology of paying off a small balance for me is quickly eradicated by the regret psychology of seeing exactly how much in finance charges I’m paying on my high rate debt! My snowball is ranked purely on APR.

  9. Hey there! I just started a new blog about my journey to debt freedom. Please check it out. I am hoping to find some people who are on the same path as me who will become regular readers! Thanks! =)

    I am also a Dave Ramsey fan, and if you are interested in trading links let me know. I’ll happily link to your blog if you’d be willing to link to mine.

  10. I like the idea… the emotional charge of the lower balances being paid quickly, then attacking higher APRs. It is great, although perhaps too complicated for some to use.

  11. From my experience, the two main motivators for getting out of debt are FEAR and PAIN.

    When we first started following Dave’s plan, it was mainly out of fear. NSF charges, late fees, and the constant fear of not having an emergency fund drove us to get on a plan. Layoff fears that many are facing today can drive it too.

    But now that we’ve been debt snowballing for 2 years (with ~3 years to go), the fear factor is relatively gone. No NSF charges anymore. No late fees. We have a $1000 emergency fund now with stable jobs. Because of our “success” so far and our relative lack of fear, I’ve noticed that we tend to bend the rules a little and buy stuff we don’t need and eat out a little more than we should. Lately, the way we’ve started fighting this urge to “cheat” is to “bring on the pain,” as we call it. The more pain you feel, the more ticked off and focused you get.

    Being the nerd in the house, seeing our one huge CC at the bottom of our debt snowball (~$13K @ 16%APR) brings pain every time I look at it, which helps me attack those smaller debts and fuels the Debt Snowball method (at one point interest on our CC was higher than the interest on our mortgage! Now that’s pain!!). As MJ said, it’s 80% behavioral. Those high interest rates at the bottom of your debt snowball are just extra pain points that should help increase you intensity.

    I’m sticking with Dave’s plan. It’s simple, and it just works.

  12. @Cameron Moore You bring up a WONDERFUL point… That high interest rate can serve as a powerful motivator… I like it! Thanks for the feedback…

  13. This is what we are doing…but I’ll let you keep rights to the name and glory. 😉

    Personally, it worked for us because my husband and I are opposites. When thinking of how to start working on our problem, he needed the snowball and I needed the avalanche. We realized that having less creditors would make us both happy and, therefore, knocking out a few of the smaller balances first would make a great start. Still working on that part at the moment. Once that’s done, I believe we will feel powerful, instead of powerless, in our struggle with our debt. That’s when we will BOTH be in avalanche-mode, be gazelle intense, etc.

  14. I quite like your idea, and for all the reasons you suggest (gets the snowball rolling, but then switches to the more financially sound idea). I’m not sure I could personally do it though – I think I like the idea of reducing the number of debts I have, rather than just the overall dollar value. Then again I’m lucky – my largest debts also have the lowest interest rates 🙂

  15. All 3 of these plans have their merits. Each of us has a different perspective on our situation, so a plan that works better for motivating person “A” may not be as effective for person “B”, even if they somehow had almost exactly matched balances with the same interest rates.

    For someone who finds paying off a given debt gives them an important boost, Dave Ramsey’s plan is probably best. While they will ultimately pay a little more in total interest, having a series of psychological boosts that help them to stick to the plan is probably more important. For another person who is more strongly motivated by trying to end the “slow bleeding” of the interest, either the Avalanche or Deluge plans may provide better motivation.

    Ultimately the best plan is whichever one helps the participant to achieve his or her goal of getting out of debt. As long as they pick a plan that gives them a good level of motivation, any one of the three will be a success.

  16. I’ve listened to dave ramsey occasionally (i like political talk radio more). the show is really repetative, different people asking the same questions, can’t even make a simple budget to find out how much all of their bills are, made bad decisions, etc.

  17. If you don’t think knocking out 7.5% of your debt in one month is big, you could add some additional information to beef up the accomplishment. For starters, you can do the math on how much more you are paying over the minimum. you could then put the total months you are saving by paying that much. Definitely keep graphs of the balance over months to show that downward slope. You could even have one slope showing where it will go, and one showing where you are.

  18. You have great thoughts in this post, NCN, and thanks for the link. No matter which method someone chooses, it’s important that they know why they are choosing it and how much money they are paying extra if they choose to do so. With knowledge, people can make informed decisions, and it’s really up to them. The idea you suggest within this post is an excellent way to “split the difference.”

  19. Personally I think Dave Ramsey has it right. The numbers don’t tend to add up to as much as you think they do, and the psychology really makes a difference.

    I just ran all three scenarios through a debt calculator. I set the minimum payments on all 5 debts to 2.5% of the balance (which used to be fairly standard for credit cards) and an extra $100 for the snowball. Any idea how quick the debts get payed off?

    Snowball: 45 months
    Avalance: 42 months
    Deluge: 44 months

    Oh, and the balance in month 45 for the snowball was only about $20, which you could probably squeeze into month 44…

  20. @Taylor: I’d try something like this for myself: keep making overpayments on the loan but also try to set up a savings account specifically for making extra big payments. For example, say you get to $1,000 in that account, pay it on the principal right away and you see a big drop, which might provide the psychological reward you need.

  21. I used to be a hardcore debt avalanche believer until just recently. I’ve decided to adjust my plan so that I pay off the debt that makes me most uncomfortable first. I have two debts, my car loan and a student loan. The car loan has a 2.5% interest rate and $360 minimum payments. The student loan has a 4.5% interest rate and $160 minimum payments. Even though the student loan has a smaller balance and a higher interest rate, I’m paying off the car first. Why? Because I know that if something happens (and with the economy the way it is it just might), it will be a whole heck of a lot easier to come up with $160 payments than $360 payments. Plus, if I end up needing to sell the car for some reason, I’ll have that much more cash in my pocket.

  22. I like you idea.

    I’m 6 months into my 2nd attempt at a snowball plan and am down to only two debts, but if I had more I’d give the Deluge a try.

  23. Brandy: You have a very good point. Working through debt right now (during this time, this economy, etc.) is a whole different world. I absolutely agree with your findings about your own situation!

  24. Let me give you an example why Dave Ramsey’s smallest debt first is the method for us.

    We have no credit card debt but we have four student loans:
    $8K @ 4%
    $22K @ 7%
    $32K @ 4%
    $50K @ 7%.
    The rate we are going we can pay $30K extra to student loans a year.

    By using Dave’s plan and paying down the smallest loans first by DEC 2009 we’ll have paid off two loans in full! If after Christmas 2009 one of us loses our job we only have two loans to worry about making minimum payments on. By DEC 2010 we’ll have another loan paid off, leaving only one loan to worry about going into 2011.

    If we pay off the highest % loans first by DEC 2009 we would have only paid off the $22K loan. And by DEC 2010 we’d still be working on paying off the $50K loan. So going into 2011 we’d still have three loans to worry about.

    It’s important to really examine your debts and evaluate the pros and cons of all (three) snowball methods. In our situation Dave Ramsey’s method works best.

  25. I don’t have a comment on which method I prefer or which I think is best, I just wanted to say that you outlined each idea well and in a concise fashion. I appreciate the ‘thinking’ about it, rather than following or promoting one way or another as best.

  26. There is a second massive flaw in David’s Plan as well. David teaches folks to pay off all their debt using the above plan that does have a math error that is true. Here is the second massive flaw David tries to convince these same hard working folks to go to his Financial Peace University at a very expensive cost and what do they do , the charge it to those credit cards that they worked so hard to pay off! WAKE UP FOLKS
    ALL HE IS TEACHING IS COMMON SENSE , STUFF YOUR PARENTS AND GRANDPARENTS OFFERED YOU FOR FREE AND YOU WERE TO STUBBORN TO LISTEN. OVERALL THE NUMBERS IN AMERICA JUST DON’T WORK most folks earn about 30 or 40 K Average living cost even if you are able to get almost everything very very cheap is around 65K this is one car for the family and bare bones living no extras at all. So where is all this other money coming from ???????? That 65 K does not count the taxes in so two people living on 80K because both have fairly good salaries no kids are spending almost everything they make just to feed and shelter themselves. This is no eating out , no parties, no extras of any kind and only one car. DO THE MATH !

  27. Dave, has on occasion recommend someone ignore the balance and get rid of a high interest loan in the case of a payday or title loan. 140% interest is tough to ignore. He has also said to pay the IRS above everyone else regardless of the balance.

  28. Fantastic post and I would have to agree. We are Dave Ramsey followers as well. I have read many financial books about debt, the whole highest interest rate first, list out the debts, etc. Money is such an emotional thing and we believe that Dave has it right and in order to really be successful and make progress you need to bang out a few debts right away or disappointment sets in.

    In combination with DR’s plan we do the 0% balance transfer option on the cards we have to reduce the interest rate instead of getting a $100 finance charge and having a minimum payment of $115 on the card does nothing to reduce the balance.

  29. 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.

    I think that both Flexo’s view and Mr. Ramsey’s view a only partial looks at the same situation. 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.

  30. What about the more emotional balance. Leave the 900 first, because it will benefit you the most by getting one done. Then, pick the next most rewarding. Is the high interest rate bothering you? Then take the 12% rate loan and get rid of it. Is the 1700 getting to you? Do that one. Is there one that falls between these extremes? Or is there a minimum payment that is painful? Take that out. No matter what order you put your debts in, it doesn’t really matter. Probably not too much to Dave either. What matters is the constant of paying extra to the loans and getting rid of them. Making good enough progress throughout so that you can feel like you are getting out of debt, and not worrying about the numbers too much, since in the end, it will be a matter of months different for most people, so just do it!

  31. Disclaimer: I’ve never had consumer debt and I am good at math. I also have money – enough to pay off all of the amounts listed in the post above with a single check. But guess what – if I had the debts listed above, I might’ve even considered keeping the debt B (3.9%) until this low interest rate holds as a hedge against inflation: I have a municipal bond that pays me 5% in interest tax free). So this is a point of view of someone who may be not “rich” but at least is “comfortable”.

    As a math major, I am really bothered by people’s paying off low interest debt first because of “psychology”. I don’t like wasting money, and to me any interest that is higher than what I can get on fixed income (!) investments is wasted money. I also don’t separate money into buckets – debt vs savings. To me it is a single pool of money – savings, investments and debt – some positive and some negatives, and the idea is to maximize the total not individual pieces.

    So instead of following a plan that results in wasted money, why not change one’s way of thinking? Instead of looking at each debt as individual entity, why not add up the numbers every month? This way, you can get a real satisfaction of your total debt load decreasing along with your monthly payments. Yes in the example above, the difference is not that large. But what if your largest debt had been at 29%? Then by the time you finish paying off small low interest rate debts, your large debt could grow by more than what you’d have paid off.

    There are other considerations too – if 3.9% expires and may go up – pay it off before the rate expires.

    Another thing – why not just get a 0% credit card and transfer everything there? Then you could comfortably pay the total for a year. A month before 0% expires you could transfer to another 0% and repeat. Needless to say you shouldn’t add to your balance in the meantime. Shuffling 0% balances, by the way, is what my friend did when she needed to pay for her mother’s cancer medication. Gave her mother 2 extra years of good quality life yet never paid a penny in interest. This friend is a millionaire now, by the way.

  32. We are in the process of using something similar to the Debt Deluge – except we used more breaks in our list… We first broke it down by type of debt – we’re paying off credit cards, then auto loans, then student loans. Then we broke the credit card category down by “balance range” – the ones $1000 or less in the first category, then the ones ~$3000, then the higher ones. This division worked for our specific balances and made very close-knit groups. Finally, we ordered each sub-group by interest rate.

    We just made the last payment on a debt that started at $3800, at 30% interest. Now we’re starting on a $3000 debt at 17% interest. When we finish it, we’ll tackle the (currently) $2100 debt at 10% interest.

    Yes, we could have paid off that $2100 debt more quickly – but the difference in payoff time wasn’t big enough to be worth the TRIPLE interest rate to us. (We got a much higher “minimum payment” added to our snowball this way, as well, due to the higher interest rate!) On the other hand, if we had tried to pay off that $3800 card before getting rid of the little $500 and $200 store cards, we never would have felt like we were making progress in the early days!

    So yes, I like the Debt Deluge – BUT I wouldn’t limit myself to drawing a line “in the middle” of the debt list. I would instead group the debts by balance into however many groups make sense based on the balance distribution. Specifically, if it were me, I would pay off the $5,000 debt before the $12,000 in the scenario you provided. $1700 to $12000 is a BIG jump in the amount of time between payoffs, and it would be easy to get discouraged looking at that situation… But I’d still get that $12k one out of the way before touching the $10k!

  33. I guess what I did was really this, to an extent. 3 cards, all with similar interest rates. Paid off the lowest balance first, then the two other cards both had similar balances. 2 cards, similar balances (within $10 of each other), similar rates… I started paying of the one with the rewards system first, so that I can use it responsibly once I get the other one paid off.

    My only problem with the debt snowball is that you knock off the first debt–GREAT! But then it takes longer and longer to knock out succeeding debts. You could easily lose motivation and enthusiasm mid-train, whereas if you knock out the highest balance first, each subsequent one goes away a lot faster.

  34. @ Taylor.

    I too have only large debts. So progress month to month seems incremental and it will be 20 more months until I see a debt be terminated.

    There are two ways to motivate yourself here:

    1) Define and learn to feel success in just staying in your budget and executing your plan. Every month is a success, in other words, because every month you kill a chunk of that debt.

    2) You can subdivide the debt into various parts. For example, if you owe $7000, divide it into chunks large enough to be paid off in three months. So if you put $600 on it, divide the debt into 7000/1800 or four chunks of $1800.

    Make a chart of the debt with the four chunks sectioned out in black outline.

    Mentally or phusically celebrate every three months when you kill one of those chunks.

    In my case, the chunks are close to $1000 and I kill one every 3 months.

    I hope this perspective helps.

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