No one likes to hear or think about it – which is sometimes part of the reason debts go unpaid, or are not paid efficiently enough, and accumulate – but there is one strategy in resolving debt that takes psychology into mind, even though you might say that paying less and using math is more important.
Student loans, mortgages, car loans, credit card debt – on different cards, with different interest rates and terms. It’s too much to mentally keep a good overview of, and many people just tune out, or decide they’ll do what they can, when they can, with no clear strategy.
Or, you may have already agreed to clearing the debt on paper, without being sure what the actual best option was for your personal financial situation at the time.
It can seem like an endless burden anyway, so why bother to choose a clear strategy, when “a lot” and “a long time” are just about the clearest you can define this mud puddle of ever-changing numbers.
Introducing two very different strategies for resolving debt: Avalanche versus Snowball
First, though, you need a clear idea of the money available to put towards this goal. Simply put: What’s the difference between how much you make and how much you spend, after all taxes and expenses; and of course, can that realistically be changed?
With a clearer idea of what you can afford each month, you can consider the two differing approaches to pay off debt. You may be surprised to see which one actually works best, despite first impressions.
Math says: Avalanche
In purely mathematical terms, the Avalanche approach is best, because it’s the most efficient. Make an overview of all debts, listing them by interest rates – the highest at the top and the lowest at the bottom.
Then, list the minimum payments that need to be made for each. You’ll pay the bare minimum on each item, except for the item listed at the top. For this item, you’ll pay everything you can, in order to resolve that debt the quickest.
Once that one is completely paid off, you’ll focus all the “extra” money on the next item on the list (the one with the second-highest interest rate) and so on. This way, more money is free to flow “downhill”, like an avalanche.
By dealing with the highest interest debt first, you’ve saved the most money possible – by paying as little interest as possible.
It’s mathematically sound, and yet, for many people, it doesn’t work. Between getting discouraged, life getting in the way, and becoming overwhelmed, the method can be hard to stick to. Debt consolidation plans can create the same problem – while it technically simplifies debt, the amount and task can become overwhelming.
Psychology says: Snowball
The Snowball method takes motivation and psychology into play, by letting you feel accomplished earlier on in the game. In being able to pay off smaller debts completely, in the shorter term, you can feel like at least part of the task is over and done with. Using momentum and a sense of accomplishment, you become more motivated, and the mountain of debt becomes less daunting.
A similar brain-hack is used by developers of addictive video games: positive reinforcements are doled out early on, more easily and often, getting you hooked. Then gradually, you have to work harder and longer for the same rewards. However, your brain goes after the same dopamine-fix, and the extra effort needed is not as off-putting.
With the Snowball method, popularised by Dave Ramsey, you’ll list your debts by balance, not by interest rate – with the smallest balance to the top. As with the Avalanche approach, you’ll pay the bare minimums on all debts, but focus all priority on the item to the top of the list. Once that item is settled, the extra cash goes towards resolving the second-highest balance, and so on.
Which is right for you?
Technically, you’ll pay more overall interest using the Snowball method than someone using the Avalanche approach. That of course, assumes that people using both methods, see the task through.
In 2012, a team of researchers at Kellogg School of Management at Northwestern University in Illinois found that “snowballers”, in pursuing the smaller victories first, were much more likely to see their debt resolution through, even when they had more debt to begin with, than “avalanchers”.
With access to a unique data set, provided by a large debt settlement company, researchers David Gal and Blakeley McShane had access to detailed information on how 6,000 people resolved their credit-card debt.
“We found that closing debt accounts – Independent of the dollar balances of the closed accounts – predicted successful debt elimination at any point in the debt settlement program,” Gal said in an article published by the school.
“The authors say their research raises important policy questions. ‘Perhaps consumers should be told of both the rationally optimal approach to eliminate debt – that is, paying off higher-interest balances first – as well as the possible psychological benefits of closing account balances. Consumers can then make an informed decision,’ McShane said.”
University of Michigan and Boston School of Business have also delved into the topic, and came to similar conclusions.
Debt will never be something you’d like to think or talk about, but considering the right strategy for you, will ease the burden somewhat and make you more likely to succeed.
The best thing is to do the math for both approaches, before choosing. If the Avalanche method would save you a significant amount, it may be worth the extra effort. Either way, try to pay attention to one debt at a time and stick to one method.
However, you should also keep track of your progress and motivation levels. If you find yourself becoming very demotivated using the Avalanche approach, which can take years to completely pay off the first debt, you can deviate somewhat to pay of a smaller loan, for a boost.
You can use online Debt Snowball and Debt Avalanche calculators, which can show you, down to the month, how long it would take you to resolve debts, using either method. Just search for the keywords, and there are many different websites that offer the service, one example is NerdWallet. Not into tech? You can also search for “worksheets” with the same keywords, print them out and fill them in by hand.
