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If you’re new to the debt-free journey, you might be lost in the sauce. You don’t know where to start in this debt-payoff process. “Which debt do I pay off first?!,” you shout. I feel you.
When I started to become financially literate, I didn’t know anyone personally who was paying off debt. I had to educate myself.
The first things I learned were YOU MUST PAY MORE THAN THE MINIMUM and ATTACK ONE DEBT AT A TIME. Don’t spread out your extra cash across two or three bills.
Why? Studies show that when you focus on one debt at a time, you knock out debt considerably faster than those who spread the wealth over multiple accounts. Your brain likes to focus on one thing at a time. Go with it.
- Put extra money (“the debt eliminator” according to Patrice C. Washington) toward one debt.
- Make minimum payments on the rest of your accounts until you pay off the first debt.
- Then roll over the extra money into the next debts until you’re DEBT-FREE! YAY!
Mathematically, the rollover method makes sense too. Look at the simplified example below.
Rolling over shaves off 2 months! Putting all of your extra money toward one debt leads to a closer debt-free date. That’s what you want. Attack one debt at a time.
So which debt do you pay off first?
There are a few ways to prioritize debts. One of the first personal finance books I read was The Total Money Makeover by Dave Ramsey. He introduced me to the Debt Snowball. I read more and discovered the Debt Avalanche. Then I started making my own methods up. Let’s go through these four methods to prioritize which debt to pay off first. Then download the free worksheet or Excel spreadsheet to pick your favorite repayment strategy.
1. Debt Snowball (smallest balance first)
This straightforward method—and probably the most well-known and applied—suggests listing all of your debts in order from the smallest balance to largest balance. Then you pay off the smallest balance first. You make the minimum payments on all of the other debts and throw every extra dime into the smallest debt. When you crush that first debt, you roll over that payment into the next debt on the list.
Hence, the snowball. The ball gets bigger and bigger with each payment you make. By the time you reach the debt with the largest balance, you’ve amassed a giant snowball that will help you pay off the debt faster than you initially imagined.
Pros: The debt snowball method allows you amass relatively quick wins. This gives you a huge psychological boost to keep you on track. The debt-free journey is not easy. Consistency, focus and small wins are key to staying motivated.
Cons: The debt with the largest balance may carry a higher interest rate than the debt with the smallest balance. So you’re racking up more interest the longer you make minimum payments. It seems counterintuitive to make the debt with the smallest balance first instead of the debt with the highest interest rate. Which leads us to the…
2. Debt Avalanche (highest interest rate first)
This method suggests listing all of your debts in order from the highest interest rate to the lowest interest rate regardless of the balance. Then you pay off the debt with the highest interest rate first. Hence, the avalanche. You go from the top rate to the lowest rate.
Just like with the Debt Snowball, you make the minimum payments on all of the other debts and throw every extra dime into the debt with the highest interest rate. The money rolls over into the next debts as you banish the balances.
Pros: High interest rates suck your money right out of your wallet at lightning speed. Many store credit cards can charge up to 30% on purchases. The sooner you knock out high interest rates, the sooner you get to keep more of your money.
Cons: Your prioritization list could look like a roller coaster. For example, the debt with the highest interest rate might carry a balance of just $500. The next debt of $4,000 has a slightly lower interest rate, but it will take you longer to pay it off. So you’ll waste more money over time because that larger balance is accruing a high interest rate.
3. Debt Volcano (the debt that “blows your top“ first)
I came up with this one. (Or I think I did. Ha ha!) The debt volcano suggests that you attack the debts in order of which ones “fire you up” or “blows your top” more. You’ll list debts from what makes you most angry to least angry.
This method is based on raw emotion. Maybe having a credit card with a 29% interest rate ticks you off more than the $20,000 student loan. If so, then you’ll start with the credit card first.
Pros: You’ll initially be fired up to get rid of debt, but…
Cons: …feelings change and motivation wanes. You’ll quit the journey if you decide to attack a $15,000 student loan first and lose motivation after 5 months because the balance isn’t going down fast enough for you. Discipline and consistency are key. Getting small wins from the Debt Snowball might be more helpful.
This method lets you choose your debt payoff strategy a la carte. Maybe you want to start with the Debt Snowball to get some quick wins. Then you decide to switch it up because two balances are similar (i.e. $700 and $850) but one has a much higher interest rate. In that case, you’ll switch to the Debt Avalanche and pay off the one with the higher interest rate first. After you pay off those balances, you might get a boost from getting rid of a debt that makes you really angry or will give you more peace of mind when it’s paid off. In that case, you’ll switch to the Debt Volcano. I’ve done a hybrid on my 18-month journey. But it’s not for everybody.
Pros: You can have it your way and fit your debt payoff to fit your mood and circumstances.
Cons: Did all that switching around make your head hurt? Yeah. That’s one of the cons. Going back and forth between methods could be a disaster. Also, emotions change. Focusing on one, straightforward plan with a clear and definite purpose and debt-free date might be your thing. So which method is best?
Let’s check out the math: Debt Snowball versus Debt Avalanche
We’ll compare the same balance using the Debt Snowball and the Debt Avalanche methods. For this example, you $600 each month to pay off debt and the starting date is July 18, 2018. The total balance of your debts is $32,000. The sum of your minimum monthly payments is $440. Your extra debt payment is $160 ($600-(40+150+250) = $160). Obviously, the bigger your extra payments, the sooner you’ll be debt-free. (Calculator: UnDebt.it)
- Credit card | $40 minimum payment | 15% interest rate | $7,000 balance
- Student loan | $150 minimum payment | 6.5% interest rate | $20,000 balance
- Car loan | $250 minimum payment | 3.5% interest rate | $5,000 balance
With the Debt Snowball, you’ll pay off all your debt by December 2023 and pay $7,350 in interest on top of the balance.
With the Debt Avalanche, you’ll pay off all your debt by December 2023 and pay $7,078 in interest on top of the balance.
For both methods, the debt-free date is the same. The difference in the total interest you’ll pay on top of your balance is $272 over a 5.3-year period. The difference is minimal. If you go by math alone, the Debt Avalanche saves more money. But we all know debt repayment isn’t about all about math. It’s about behavior.
So which method is best?
Drumroll, please. The best method for most debt-free journeyers is the Debt Snowball. The anecdotal evidence from Dave Ramsey enthusiasts is overwhelming. Check out his books, YouTube videos, radio show and Instagram posts to see how millions (yes, millions) of people have beat debt and become wealthy following his 7 Baby Steps. Baby Step 1: Save up at least $1,000 for emergencies. Baby Step 2 is to crush debt with the Debt Snowball. The Debt Snowball is tried and true.
“…it is not the size of the repayment or how little is left on a card after a payment that has the biggest impact on people’s perception of progress; rather it’s what portion of the balance they succeed in paying off. Thus focusing on paying down the account with the smallest balance tends to have the most powerful effect on people’s sense of progress – and therefore their motivation to continue paying down their debts.” – Remi Trudel, Boston University
Those small wins lead to BIG change!