In the world of personal finance, there are plenty of heated debates. Should you save for an emergency or pay off debt first? Is any debt "good" debt? Are balance transfers an acceptable way to pay off debt more quickly?
And then there's the classic argument: debt snowball vs. debt avalanche.
Before we launch into the nitty-gritty of the "which is better" argument, let's talk about what a debt snowball and a debt avalanche are.
Debt Snowball vs. Debt Avalanche
Both of these methods acknowledge a basic fact: you need a plan when it comes time to pay off debt. If you just start throwing a bit extra at debts at random, you'll likely fail. Your best bet to becoming debt-free is to pay off your debts in a methodical, planned manner.
Snowballs and avalanches are both methods for paying off debt. The only difference between them is in the approach
The debt snowball was popularized largely by personal finance giant Dave Ramsey. The idea is that you start paying off your debts with the smallest balance first. Make all your monthly minimum payments. Then throw any extra funds at that smallest debt balance.
Once that debt is paid off, continue paying the previous minimum payment amount, but put it toward the next-to-smallest balance debt. Each new debt you pay off then essentially rolls into the next one. In this way, you "snowball" your minimum payments, putting more money toward your debts each month until they're all paid off.
The debt avalanche is similar in that you roll your minimum payments together as you pay off debts. Where it differs is in the order in which you pay off your debts. Instead of starting with the smallest balance, the debt avalanche has you start with the highest-interest debt. Rank your debts by interest rate, and then pay them off in reverse order, following the same "rolling" method as the debt snowball.
Why the Difference?
Having a plan to pay off your debts is, any way you slice it, a good thing. So why is there so much debate about which plan is best? Ultimately, it comes down to two things: math and psychology. With math, the debt avalanche always wins. But with psychology, the debt snowball usually does.
The Math Behind the Avalanche
If you know much about compounding interest, the mathematically correct way to pay off debts should be obvious to you. Knock out your highest interest rates first and you'll save money over the long haul.
And this is true. In some instances, the difference could be hundreds or thousands of dollars in interest. You can use an online debt calculator to run the numbers. It'll show you just how much you'll save by using a debt avalanche rather than a debt snowball.