There are many good reasons to work on paying off your debt. Over time, your financial obligations and the size of your monthly payments may shrink. You can free up more cash for investing, saving, or just having fun. Making timely debt payments can even help your credit score.
But what is the best way to pay off debt? Here we break down two of the most popular debt repayment strategies – the debt snowball and the debt avalanche – so you can determine which method is right for you.
With the debt snowball method, you focus on paying down your smallest debts first, and work your way up the ladder. For example, if you have a $2,000 credit card balance, a $1,500 car loan, and a $10,000 student loan, you would pay them off in the following order:
- First: $1,500 car loan
- Second: $2,000 credit card balance
- Third: $10,000 student loan
You would simply make the minimum payments on your larger debts while putting extra money toward the small car loan. Once the car loan is paid off, you will move onto the next smallest debt you have.
Paying off the smaller debts first allows you to quickly clear away debts one by one, which can be very psychologically rewarding. You will feel like you are making progress and you will be freeing up extra cash to put toward those larger debts.
In short, the debt snowball method allows you to quickly clear away debts and receive a mental boost from seeing them disappear.
With the debt avalanche method, you focus on paying down your debts with the highest interest rates first. For example, if you have a student loan with a 7% interest rate, a credit card with a 19% interest rate, and a car loan with a 4% interest rate, you will pay them off in the following order:
- First: 19% credit card balance
- Second: 7% student loan
- Third: 4% car loan
You would make the minimum payments on your debts with lower interest rates and focus on putting extra money toward the highest interest rate. Once the credit card balance is paid off, you will start working on the next highest interest rate.
When it comes to pure mathematics, the debt avalanche method makes the most sense. Paying down the higher interest debts first will save you the most money in the long run, as you’ll end up paying less in interest.
Which Method is Right for You?
At the end of the day, the best debt repayment method is the one that you’ll stick with – there isn’t necessarily a superior strategy as long as you’re committed to paying off debt.
The debt snowball method is a solid strategy when you have lots of small debts or you want to see short-term progress by eliminating your debts one by one. Knocking out debts can help you stay motivated and reduce your amount of monthly payments.
The debt avalanche method is a good strategy when you’re numbers-oriented, and you want to save the most money on interest in the long run, no matter how long it takes to reduce your debt. This can help you put more money back in your pocket by reducing the interest you pay.
In some scenarios, both strategies may dovetail – the highest interest debt may also be the smallest debt you have.
Remember that whichever strategy you choose, you still need to make minimum payments on your other debts. Paying down debt might require budgeting, refinancing loans, and even making lifestyle adjustments to free up more cash for debt repayment. You also might want to avoid taking on any additional debt until you are able to significantly reduce your existing obligations.