Snowball Vs. Avalanche - How To Pay Down Debt
Paying Down Debt in a Winter Wonderland
It must have been ‘Winter Wonderland’ theme day at the gooroo outing when debt paydown methods came up. You can use the snowball method to pay down your debt or you can do the avalanche method.
What in the frozen hell does it mean?
And what should you do if you have debt you want to pay down?
What is the Avalanche Method of Debt Repayment?
Under the avalanche method, you pay off the highest interest debts first. These are the debts that will be accruing the most interest - aka the most costly debt to you.
If you have a bit of the ‘tism or you understand finance or math, your reaction may be very similar to mine, “um duh, what else would you do? There is literally no other way that even begins to make sense”.
You intuition is telling you that any method that doesn’t focus on removing the most expensive debt first is subpar…and your right.
But for completeness, lets do an easy example of the Avalanche Method.
Avalanche Method of Debt Repayment - Example
For a simple example, let’s assume:
Student loan: $8,000 balance at 3.50% interest and $350 payments
Car loan: $7,000 balance at 3% interest and $215 payments
Credit Card Debt: $10,000 balance at 17% interest and $150 payments
Total Debt: $25,000 balance at 8.75% interest and $715 payments
You have $1,000 a month to spend a month
Under the Avalanche method you would spend $435 a month paying down your credit card debt as it is the highest. ($435 = $1000 budget - $350 minium student loan payment - $215 minimum car payment)
Once the credit card debt is paid you add the $435 to the next highest interest debt, student loan. Therefore, you start paying $785 to the student loan. And finally you pay the full $1,000 to the car loan every month.
In this example, it takes 28 months to pay off all the debt. You pay a total of ~$27,750 on the $25,000 debt. Your total interest is ~$2,750.
What is the Snowball Method of Debt Repayment?
The snowball method is where you pay the lowest balance debt first. Then pay the next lowest balance and continue rolling the extra payments into the next highest balance debt.
Why would you not pay the highest interest debt since that is the one that is most costly?
The theory here is “the psychological boost you get from paying off a loan fully will help you stay on track of paying off debts”.
This is the method proposed by Davey Boy Ramsey.
The cynical person in me says, Davey Boy realized his audience is so financially illiterate that they couldn’t understand the interest rate. So Davey Boy told them to pay off the lower balance instead. However, the less cynical part of me…well..the less cynical part of me just kind of shrugged and agreed that the snowball method is another example of advice that makes his followers worse off….at some point you need to ponder if he is purposely dragging out your path to wealth so you need to keep using his products….
Snowball Method of Debt Repayment - Example
Same example as above, copied here for convenience:
Student loan: $8,000 balance at 3.50% interest and $350 payments
Car loan: $7,000 balance at 3% interest and $215 payments
Credit Card Debt: $10,000 balance at 17% interest and $150 payments
Total Debt: $25,000 balance at 8.75% interest and $715 payments
You have $1,000 a month to spend a month
Under the snowball method, you would pay off your car loan first, despite it having the lowest interest rate. So you would pay $500 to the car loan first ($500 = $1000 budget - $350 Student loan minimum payment - $150 credit card minimum payment).
When the car loan is paid off, you pay $850 to the student loan, and finally $1,000 payment fully goes to the credit card.
It takes 29 months to pay-off all $25,000 of debt and this time your total interest is ~$3,775.
Comparing Avalanche to Snowball Methods
So how do the 2 methods compare?
The interest you paid in the snowball method is over 1/3 higher in the above example. This is because you waited to pay down the credit card debt to the end.
“F’er, you chose the numbers so the credit card debt had the highest balance”. Correct.
This is an illustrative example to highlight why the snowball method is subpar. Here is the thing, the snowball method will ALWAYS have you pay more interest than the avalanche method for the same payments. ALWAYS.
“The snowball method of debt reduction will always result in more interest & higher cost than the avalanche method. The snowball method will cost you money to use”
-F’er
Are There Alternative Methods to Pay Down Debt?
Outside of the snowball and avalanche methods, is there any other ways to pay down your debts?
I may be partial, but if you have good credit and can open a credit card with 0% promo APR on new purchases for 18 months, a better solution is “F’er’s patented ‘infinite debt cheat code”.
If you could get a $10,000 limit on a brand new card, you could pay off the entire $25,000 debts you have for under $500 in total interest. A 75%+ reduction in your interest paid vs. the snowball or avalanche methods.
…maybe I need a frozen-themed name for my debt payment method…
“F’ers Marshmallow Method To Pay Down Debt”
Many of the other options commonly given don’t make a material difference in debt repayment unless you have a ton of high-interest debt. The below methods are one form or another of ‘consolidating current high-interest debt into lower interest debt’. Rolling any high interest debt into a lower rate can be very helpful, but if you just have a lot of low to moderate interest debt the impact here won’t be huge. These include:
Consolidating loans
Home-Equity Line of Credit (HELOC) if your a homeowner
401k Loan / Retirement loans
Debt Settlement
Consolidating loans, HELOCs, and 401k loans will give you a new interest rates. Additionally for any 401k or retirement loan, you are going to also be missing out on potential investment growth from staying invested, so there is some additional opportunity cost.
[Note - I was going to wrap up the article here, but wanted to be fair. So I went to Davey Boy’s site to see if he used an example on his snowball method pages. I assumed it would be something that painted the snowball method in a positive light. Boy I was wrong…The old grifter is too dumb to even put a favorable example on his site…
He really is counting on his followers being completely finanically illiterate. I added this section below…
Dave Ramsey’s Snowball Example
I refuse to link to his site, but here is the screen shot with the web address.
I ran a similar set-up as above, $1000 a month is assumed to go towards all the debts. Minimum payments are:
$350 for Credit Card
$130 for Personal Loan
$120 for Student Loan
$250 for Car Loan #1
$60 for Caro Loan #2
$910 total assumed payments
The results…just as ugly for the snowball method as my example. You will take over 1/2 a year longer and pay nearly $7,000 more in interest to pay off your debt.
Again - your gooroo is recommending a method where you pay 30% more interest.
Additionally, he actively recommends NOT trying to refinance your loan or do a balance transfer, even on the credit card at 20%. It takes ‘time’ and is too confusing apparently. His advice is genuinely to wait years while you pay off all your low balance debt before paying down the 20% credit card…literally just have 20% interest expense sitting there…it is unfathomable to me….It if $4,000 a year of interest expenses you are accruing.
Even if you are a Ramsey follower and want to do the snowball method, please transfer out that credit card balance. That is atrocious]
Summary: Snowball vs Avalanche Method of Debt Repayment
In conclusion, the snowball method has you paying significantly more interest and takes longer than the avalanche method. It is silly that this is even a thing. On the gooroos own site it cost you 30% more interest in his hand-picked example.
Either you want to pay down your debt or you don’t. Psychological benefit of the snowball method seem overblown and not worth an extra 30% interest.
Lastly, both methods can be improved upon if you have any high-interest rate credit cards that you are able to refinance to a lower rate. Or even better…The infinite debt cheat code aka the Marshmallow Method - is a great example of dropping your interest rate to zero.
And remember, all debt is easier to paydown if you have high enough income. Much easier to make an extra $12k a year with a side income than it is to be frugal and try to save an extra $12k.
Is there a downside to refinancing private student loans?