What is the difference between the snowball and avalanche method of debt repayment?


What is the difference between the snowball and avalanche method of debt repayment?

Today majority of people buy electronic devices, cars, homes and pay higher studies expenses through borrowing loans from financial institutions and this has contributed to the global debt to be in trillions of dollars.

Debt has become a major money eater for a lot of households and many people want to get rid of this money eater. Today, I will be giving you guys with two best strategies that people use to become debt free. The two methods are:

1.Snowball method: The snowball method of debt repayment involves paying off those debts first which are smaller in value. The reason why people follow this method is that it gives the person a sense of momentum and progress in his aim to eliminate debt. So for example, let us say you have the below mentioned portfolio of debt.

 Debt TypeAmount 
Credit Card 18%$500 
Car Loan 9%$3900 
Student Loan14%$20000 
Home Loan 7%$120000 

In this portfolio, you will continue to make the minimum payments for all the loans (least possible EMI) and you start by paying the smallest loan first with any extra money that comes your way. So when you attack these loans one by one, you see reduction in number of debts and then you have money which you paid for smaller debt to be now used for the larger debts. Now suppose you have an extra $250 per month from a side hustle to repay debts, then according to the portfolio you will get rid of credit card debt in 2 months, then car loan in around 15 months, then gradually the remaining debts as well because now even the minimum payments that you were making for credit card and car loan add to the $250 you were using earlier and go into student loan.

This way you see real progress and it gives you the drive to continue paying off debts. There is an upside of mental peace and satisfaction in this case but there is an issue when you take the mathematicians or finance guy's perspective. You end up paying more for the same debt. Confused? Well, take a look at the avalanche method then.

2.Avalanche method: Avalanche method is something which is chosen by those who don't mind having more number of debts but ultimately paying less overall to get rid of debt. Now Avalanche method involves paying off those debts first which carry a higher interest rate. In the above portfolio you will pay off 18% credit card first and then the 14% student loan and thereafter the 9% car loan and the 7% home loan respectively. This way what happens is that you save up on the high interest payment on loans and eventually end up paying lower money to ultimately get rid of debt, which means you actually achieve your goal a bit earlier. So mathematically the avalanche method is better but with the mindset view, the snowball method gives you motivation.

The important thing to understand here is that if you are taking a step towards debt elimination, you are on the right path and no matter which method you feel comfortable with, the crucial thing is to adapt one and implement strategies to exercise it.

Thanks for reading!

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Comment on any query you had like me to address.

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