If you want to be debt-free, then this post is the one you don’t want to miss!
Paying down your debt, imagine! You can be debt-free! Let me show you the two paths you can follow! You can first pay off your smallest debt; this is the debt snowball method. Or you can first pay off the debt with the highest interest rate, and this is the debt avalanche method. And as a bonus, at the end of this post, I will reveal to you what kind of debts you should keep for achieving financial freedom!
You can also watch my video “Paying Down Debt – The Fastest Ways to Be Debt-Free! Debt Snowball and Debt Avalanche Methods!” on my YouTube’s channel. Check it out!
You need to find extra cash!
Each of the strategies has its advantages and drawbacks, so let’s look at how they both work, and you will know which one is the best for you.
First, there is only one method to pay off your debt fast. You need to find extra cash to pay off the balances quickly. Maybe you can live on a tighter budget, it is one way to do it, or you can earn more money, either by finding a better paying job or do a side hustle. My previous video was on how to save for a down payment; however, you should apply the same tips to find extra cash. Check it out!
So now you found extra cash, $25, $100, or even maybe $500. Which debt should you repay first? The debt snowball and the debt avalanche strategies will guide you! Many people have followed these steps before you, and are now debt-free. You can do it!
The debt snowball method
Before applying the first debt-killing method, the debt snowball, you list all your debts, and you sort them by the remaining balance from the smallest to the biggest. The idea of the debt snowball method is to first pay off as fast as you can the debt with the lowest balance. Since it is the smallest debt you have, it is the debt you can pay off the fastest. Once it is paid off, you move to the next smallest one. This time, you use your extra cash plus the money freed by the repayment of the first debt. Your repayments are snowballing. They increase rapidly in size, and you repay the next debt even faster than the first one. Then you repeat the same steps until you are debt-free!
The main advantage of the debt snowball strategy is that paying down your smallest debt first is psychologically the easiest way. You will be able to pay off quickly the first one, then go to the next smallest one. Since you have more money left each time a debt is paid off, you will pay off faster and faster each following debt. It is the pace of paying off your debts and seeing the results quickly, that makes it so rewarding and simpler to follow. You will see the actual results, and it helps you to stay motivated.
So even if it is not the fastest, you may find it the easiest way to be debt-free. If you need short-term victories, you should use the debt snowball strategy.
The debt avalanche method
The fastest way to pay off debt is the second debt-killing method. As with the debt snowball, you list all your debts. However, instead of ordering your debts by the balance, you sort them by the interest rate charged. The highest interest rate debt first, the lowest interest rate debt last. And when I say interest rate, I do not mean the APR. I mean the ongoing interest rate. For example, if you have a mortgage with a 4% interest rate, and 4.5% APR, then use 4%. If you paid points at the loan origination, it is already done, and this is why you have a higher APR, but the ongoing cost of your mortgage is 4%. The idea of the debt avalanche strategy is for you to pay off the debt with the highest interest rate first. Why? Because it is the debt that is the most costly. Each dollar paid toward this debt will help you to save the most. You kill the most toxic debt first!
Then it is the same thing as with the debt snowball method. You use your extra cash plus the money freed by the repayment of the first debt to pay off the next debt. However, the following debt to kill is the next most expensive one. And you repeat until you are debt-free!
The two huge advantages of the debt avalanche method are that it is the fastest way to pay off your debts, and you save the most money by applying it. One drawback of this strategy is that your most toxic debt may be one that will take more time to repay, so when you start, it is not as rewarding psychologically as the debt snowball method. So you have to stay focused on the prize. At one point, you will begin repaying your other debts faster than with the debt snowball strategy, and this is why it is, in the end, the fastest method.
But you have to have the financial stamina to apply it successfully. Dave Ramsey believes that the debt snowball is the most natural strategy to follow for a lot of people. And I agree, though, I think you should try the debt avalanche method if you can. You can do it!
One tip you can use, to make it easier, is to imagine you are investing your money at the interest rate of your debt. If you have a credit card debt at 22%, close your eyes, and visualize you are putting your extra money in a saving account that pays you 22%. It is somewhat true. And I find it helps to not drop the ball!
An example: debt snowball vs. debt avalanche methods
Let me show you how fast you can repay your debt, and how much you can save with both methods.
I created an excel spreadsheet comparing both the debt snowball and debt avalanche methods. You can download it at the bottom of this post.
The outstanding debt and the extra cash
Quickly, let’s say we have Sarah and she has five loans or credit card debts, for a total outstanding balance of $207,000. If she does nothing, she will pay off her debts in 15 years, and she pays nearly $91,000 in interest.
Now imagine she is budgeting, and she can direct $500 extra cash, each month, to paying down her debts. She wants to be debt-free fast!
Applying the debt snowball method
If she uses the debt snowball method, she orders the debts by the remaining balances. And she starts repaying faster the smallest debt. She can do it in 9 months only. The last month, the $500 extra cash is split between the first and second debt to kill. And in month 10, the payment increase by the freed money since the first debt is paid off. And she repeats it until she is debt-free.
It takes her 7 years and 11 months, instead of 15 years. And she spent around $55,000 in interest, instead of $91,000. Nearly a $36,000 difference she keeps in her pocket.
Applying the debt avalanche method
Then she considers the debt avalanche method. So she sorts the debts by the most toxic first, the one with the highest interest rate!
As expected, it takes more time to repay it, since it is not the smallest one. But Sarah is focused on the prize. The most toxic debt is paid off in 28 months. It takes more than two years! Then the next one takes another year.
Overall she can be debt-free in 7 years and 9 months. Only two months less than the debt snowball. However, look at how much she pays in interest, only around $48,000. She saved nearly $43,000! And when you compare both methods, by using the debt avalanche strategy instead of the debt snowball strategy, she keeps about $7,000 more in her pocket!
Bonus: when you should not pay off your debts early?
Now you know the two strategies you can use to be debt-free! However, since you go down the road of financial freedom, do you know that it is not always in your best interest to pay off all your debts? Yes, it is true, you may consider keeping some debts because they will make you wealthy!
Can you guess which ones? You should keep the debts you use to buy income-producing assets, or assets that increase in value with time, or even better that do both.
It makes a lot of sense to invest in real estate by taking a mortgage. You use somebody else money to control a large asset, and somebody else is paying the mortgage for you, your tenants! If you are into collectible items, like coins, cars, art, if they appreciate over time, it may make sense to use debt to purchase them. Or you can invest in a business. As long as the total return of the asset, which means income plus appreciation, is higher than the interest rate you pay, then it is good debt. And this is the kind of debt you want to keep, or even increase!
Therefore, if you use the debt snowball or debt avalanche methods, usually the last debt remaining is your mortgage. Interest rates on mortgages are low. If you have a high-interest rate mortgage, try to refinance it. I know it is nice to be mortgage-free. But you may be better off keeping it and try instead to build your wealth. I know it is one step higher, but I am confident you can achieve it. Check out my posts on leverage and financial freedom if you want to know more.
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Questions of the day:
On the path of paying down debt, what debt-killing method would work for you, the debt snowball method, or the debt avalanche method? Do you prefer the pay-off pace of the debt snowball strategy or the higher savings of the debt avalanche?