Paying off debt doesn’t look the same for everyone. Life circumstances, income, and living expenses all need to be factored into the plan. Behavioral patterns and levels of self-discipline are variables also, particularly when choosing a long-term strategy. Most importantly, every plan requires that you create a budget. It’s a good idea to do that first before reading on.
In today’s article, we’ll talk about three types of debt payoff methods:
- Debt Snowball
- Debt Avalanche
- Hybrid Debt Payoff Methods
One of these might be the right fit for you. Go over each of them carefully and don’t just look at the numbers. There’s a level of commitment required to follow through on a plan that could take several months, even years to complete. If either debt snowball or debt avalanche doesn’t work for you, consider a hybrid debt payoff strategy, which is a combination of both.
What is Debt Snowball?
Begin debt snowball planning by making a list of all your outstanding balances and list the interest rate (APR) that you’re paying on each of them. This list will be your “master” for all three debt payoff methods, so hold onto it. You might want to use a spreadsheet application such as Excel or Google sheets so you can easily sort and order your accounts.
Personal finance author Dave Ramsey advocates debt snowball as the best strategy to pay off debt. Here’s how it works: you’ll make all your minimum monthly payments and then add an extra payment to the debt with the smallest balance each month until it’s paid off. Once that’s done, apply the same strategy to the next smallest balance. You can use a debt snowball calculator to plug in the actual numbers and see when you’ll be debt-free.
The primary purpose of using a debt reduction strategy is obviously to pay off debt, but some methods are easier than others. Debt snowball helps you gather momentum early in the process because you’ll see those small balances go to zero quickly.
What is Debt Avalanche?
Unlike debt snowball, which focuses on balances, debt avalanche prioritizes interest rates. You can use the same list that you created in debt snowball, but now, sort it by interest rate, from high to low. Make all your minimum monthly payments and add the extra payment to the account with the highest interest rate. Rinse and repeat. Use a debt avalanche calculator to do the math.
The debt avalanche method doesn’t provide the same instant gratification that debt snowball does because the highest interest rate account may not be your smallest balance. It could take some time to see a zero balance. If you don’t mind waiting, eliminating those high interest rates early in the process cuts down the total amount you’ll pay over the life of the plan.
What are Hybrid Debt Payoff Methods?
Hybrid debt payoff methods are debt reduction strategies that incorporate elements of both debt snowball and debt avalanche. There are a number of hybrid methods, but we’ve compiled a short list of the most popular for your review.
Savvy Debt Payoff Method
Choosing the debt snowball method is often viewed as a mistake because you end up paying more over the life of the plan in interest. A debt avalanche will save you money, but it doesn’t offer the same psychological boost from early “wins.” The savvy debt payoff method combines both. You prioritize small balances, but interest rates also come into play.
Think of it this way. If you have three outstanding balances between $1,500 and $2,000 and they are your three smallest, plan on paying them all, but start with the one with the highest interest rate, even if it has a higher balance than the other two. Think of it as paying off “tiers” instead of knocking out single accounts. It’s the best of both worlds.
The Debt Fireball Method
The debt fireball starts with separating good debt from bad debt. Good debt is the kind that produces a return for you, like student loans and mortgages. Credit card debt and auto loans are considered bad debt because you either have no return or a depreciating asset. With debt fireball, you pay off bad debt from smallest to largest, based on balance.
Debt Tsunami Method
The debt tsunami is a more abstract concept than the others we’ve listed here. It calls for you to pay off debts based on their emotional impact. In that scenario, either debt snowball or debt avalanche could be the right solution. Once would quickly cut down the number of debt accounts. The other would create more disposable income. Both are emotional triggers.
Debt Snowflake Method
The debt snowflake can be highly effective, but it requires some dedication to follow it through. The concept is that you try to save money during your everyday activities, then apply those small savings (snowflakes) to your outstanding debt. A common example of this is to buy a small sub instead of a large one at lunchtime. You’ll save about $2.00 and can apply that to a debt payment.
Debt Spiral Method
The debt spiral method is for those folks who are more mathematically inclined. It ranks accounts based on the debt-to-interest ratio, which is a number calculated by dividing your debt account balance by its interest rate. Once you’ve arrived at that number for all accounts, prioritize them from highest DTI to lowest. Then, focus on paying them off in that order.
Key Takeaways
This is a lot of information to absorb, so we’ll summarize some of the key points to help you digest it. As a consumer dealing with high and low-interest debt, this is what you need to know:
- Debt snowball will get those small accounts paid off quickly
- The Debt avalanche will save you money on interest payments
- Debt hybrid combines the best of both options