I realize as I start typing this that passionate Dave Ramsey fans will probably be thoroughly annoyed with this post. But, before you passionate snowballers get too upset, hear me out. I love Dave Ramsey’s Baby Steps and the snowball method. My dad actually introduced me to his books while I was still in high school (thank you dad, I am forever grateful). If you have no idea what I’m talking about you can grab a copy here.
The reason I’m even bringing up the avalanche method is because it saves you a lot on interest. Lately I’ve been struggling with which method to really commit to. Isn’t the whole point of getting out of debt and living frugally to save money? The answer is obviously yes. So, why are we all so passionate about using a method that takes longer and costs more?
The great thing about the snowball approach to paying off debt is the momentum it builds and by momentum, I mean confidence. Just a quick catch up for those of you unfamiliar with this strategy: start by paying off the smallest debt and end by paying off your largest balance. Interest rates don’t matter. Even if your largest balance has the highest interest rate of all your debts, you’ll be paying it off last.
Why it Works
Like I said, this method gives you big boost in confidence when it comes to your ability to make progress on your debt very early on in the process. A lot of people need that. I know I do. If you start out trying to pay off a $10,000 balance, I really wouldn’t blame you if you got discouraged and just gave up.
Why it Doesn’t
Okay, to be fair, both of these methods will “work”. But, the major issue with the beloved snowball method is the extra money you end up paying on interest while you’re knocking out those smaller debts with potentially low, non-threatening interest rates. Let’s take a look. I personally love this chart from Nerd Wallet that calculates the interest paid using both the snowball method and avalanche method.
The avalanche method is for saving the most on interest. Instead of starting with the smallest balance, you start with the debt with the highest interest rate.
Why it Works
Well, this should be fairly obvious. You save a ton of money by using the avalanche method because you don’t keep paying high interest for prolonged periods of time. If you don’t believe me, sit down with all your debt and do the math. Paying it off based on interest will probably save you at least $1000 but that depends on how much debt you have to begin with.
Why it Doesn’t Work
Again, both of these methods will work to pay off your debt but the avalanche method is definitely for the patient. You don’t necessarily get the instant confidence boost you’d get with the snowball method. Unless, of course, your debt with the highest interest rate also happens to have a small balance. Unfortunately for us, our lowest debt is about $175 and our debt with the most annoying interest rate has a balance just under $3000. Boo.
How to Create a Custom Plan
With all the debating going on in my head, I’ve decided it’s best to come up with a custom plan that combines the best of of these two strategies. Additionally, I have considered the size of the minimum monthly payments.
One of our biggest problems right now is how much of our income goes toward paying on debt. It can get really tight sometimes and neither of the strategies take that into account. In my mind, I’d rather pay off the debt that impacts the most each month than pay off one that only takes $40 from our income. Freeing up a $150 monthly payment would mean paying off the rest of our debt a lot faster, right?
So, how do you create a custom debt repayment plan that will free up income quickly, boost your confidence, and save money on interest?
The first thing you want to do to figure out your approach to debt repayment is to compile all of your debts in a list detailing the balance, minimum payment, and interest rates. This is best done in a Google Sheet or Excel document because you will be rearranging your list a few times. I also suggest you print these and track your progress with a Debt Diary binder. You can find out how to make one and grab some free printables here.
The first list or spreadsheet should be organized by the current balance from smallest to largest. This would be your repayment plan if you were using the snowball method.
The second list should be organized by interest rate largest to smallest. Yep, you guessed it. This is what the avalanche method looks like.
Finally, the third list should be organized by minimum monthly payment largest to smallest. If this strategy already exists, please let me know what it is called in the comments!
See why it’s best to do this in a spreadsheet? You can just copy each list and not have to worry about manually sorting the data every time.
Decide What’s Important
How bad do you want to knock a debt off your list? Are you patient? Will a large balance discourage you? These are the questions you need to ask yourself after you have compiled all of your debt data.
For us, I decided the first thing we are going to pay off is a really, really small balance that has no interest rate. Why? Because it’s only $175 and it has been sitting in collections for a while. I just want it gone and I want to be able to write a letter asking them to remove it from my credit report sooner rather than later. This will be a nice boost in confidence and take care of some credit issues.
The next thing I looked at was the monthly payment. I want to free up some of our hard earned income! Unfortunately our highest monthly payment is going to a $10,000 credit card balance and that is NOT something I want to try to pay off first. Close behind it however, is a nice $2,500 debt. This debt also happens to have THE WORST interest rate (31.34% people) so that will get paid off second.
For the remainder of my list I threw in a pretty small $500 debt with a low monthly payment just for a little boost in momentum. Then I pretty much went by interest rate, highest to lowest, to maximize savings over time. It’s all about balance when you’re making a custom debt repayment plan.
By the way, our car is the last thing we are paying off even though it has a high balance and the highest monthly payment. We don’t own a home so paying this debt will kind of be like paying off our mortgage. 🙂
There isn’t a debt repayment plan in the world that will work if you don’t. Once you decide on the right plan for you and your family, hustle, pay off the first debt on your list, and keep going. It will be so worth it a year from now. If you’d like to find out more about how I’m working to pay off debt by freelancing, check this out.
So, what is your debt repayment strategy?
If you’ve just started your personal finance journey, I strongly recommend picking up Dave Ramsey’s Total Money Makeover book. It has created a strong foundation for managing my finances and I’m so grateful to have read it in my young adult life.