Debt snowball – FIRE-Invest

Debt is a common financial concern for many individuals and households. It can be challenging to manage multiple debts and stay on top of payments, leading some to explore strategies such as the debt avalanche and debt snowball methods. In this article, we'll compare these two approaches and provide calculations and references to help you determine which one might be right for you. The Debt Avalanche Method The debt avalanche method is a debt repayment strategy that focuses on paying off debts with the highest interest rates first. The idea is to minimize the amount of interest you pay over time and to reduce the total amount of debt you owe. To use the debt avalanche method, you will need to follow these steps: List all of your debts from highest to lowest interest rate.Make minimum payments on all debts.Put any extra money you have towards paying off the debt with the highest interest rate.Once that debt is paid off, move on to the next highest interest rate debt and repeat the process until all debts are paid off. Let's look at an example to see how this works. Say you have three debts: Credit Card A: $5,000 at 20% APRPersonal Loan B: $10,000 at 10% APRCar Loan C: $15,000 at 5% APR Using the debt avalanche method, you would focus on paying off Credit Card A first, then Personal Loan B, and finally Car Loan C. You would make minimum payments on all debts, but any extra money you have would go towards paying off Credit Card A first since it has the highest interest rate. Once that debt is paid off, you would move on to Personal Loan B and so on. The Debt Snowball Method The debt snowball method is another debt repayment strategy that focuses on paying off debts in a specific order. Unlike the debt avalanche method, the debt snowball method prioritizes paying off debts with the smallest balances first, regardless of interest rate. The idea is to gain momentum and motivation by paying off debts quickly, which can help you stay motivated to continue paying off your other debts. To use the debt snowball method, you will need to follow these steps: List all of your debts from smallest to largest balance.Make minimum payments on all debts.Put any extra money you have towards paying off the debt with the smallest balance.Once that debt is paid off, move on to the next smallest balance debt and repeat the process until all debts are paid off. Let's look at an example to see how this works. Say you have three debts: Credit Card A: $5,000 at 20% APRPersonal Loan B: $10,000 at 10% APRCar Loan C: $15,000 at 5% APR Using the debt snowball method, you would focus on paying off Credit Card A first, then Personal Loan B, and finally Car Loan C. You would make minimum payments on all debts, but any extra money you have would go towards paying off Credit Card A first since it has the smallest balance. Once that debt is paid off, you would move on to Personal Loan B and so on. Comparison of the Debt Avalanche and Debt Snowball Methods Now that we have reviewed both the debt avalanche and debt snowball methods, let's compare the two to see which one might be best for you. The debt avalanche method is generally considered the most financially savvy option since it prioritizes paying off debts with the highest interest rates first. By doing so, you will pay less interest over time and potentially save more money. However, the debt avalanche method can be more challenging to stick with since it may take longer to see progress, especially if your highest interest rate debt has a large balance. It requires a lot of discipline and patience to stay committed to the plan over the long term. On the other hand, the debt snowball method can be more motivating since it prioritizes paying off debts with the smallest balances first, allowing you to see progress more quickly. This can provide a sense of accomplishment and help you stay motivated to continue paying off your debts. However, the debt snowball method may not be as financially savvy as the debt avalanche method since it does not prioritize paying off high-interest debt first. Ultimately, the best debt repayment strategy for you will depend on your personal financial situation and goals. If you have high-interest debts, the debt avalanche method may be the most effective way to reduce the amount of interest you pay over time. However, if you have smaller balances and need a motivational boost, the debt snowball method may be the way to go. Calculations To illustrate the difference between the debt avalanche and debt snowball methods, let's look at an example. Suppose you have three debts: Credit Card A: $5,000 at 20% APRPersonal Loan B: $10,000 at 10% APRCar Loan C: $15,000 at 5% APR If you make minimum payments on each debt, it will take you approximately 160 months (over 13 years) to pay them off, and you will pay a total of $22,059.36 in interest. Using the debt avalanche method, you would pay off Credit Card A first, then Personal Loan B, and finally Car Loan C. If you pay an extra $500 per month towards your debts, you would pay off all three debts in approximately 3.7 years and pay a total of $7,235.91 in interest. Using the debt snowball method, you would pay off Credit Card A first, then Personal Loan B, and finally Car Loan C. If you pay an extra $500 per month towards your debts, you would pay off all three debts in approximately 4.4 years and pay a total of $8,108.27 in interest. As you can see, the debt avalanche method allows you to pay off your debts faster and with less interest paid overall. However, the debt snowball method may provide a motivational boost that helps you stay committed to your debt repayment plan. References Dave Ramsey. (2021). Debt Snowball vs. Debt Avalanche: What’s the Difference? Retrieved from https://www.daveramsey.com/blog/debt-snowball-vs-debt-avalancheInvestopedia. (2021). Debt Avalanche vs. Debt Snowball: What's the Difference? Retrieved from https://www.investopedia.com/articles/personal-finance/100215/debt-avalanche-vs-debt-snowball-which-best.asp