Two Strategies for Digging Out of Debt
If you owe money to credit card companies, the bank financing your car, and the federal government (for your student loan), the good news is you are not alone! Outstanding student loan debt reached an all-time high of $1.41 trillion in 2019, and that’s just one slice of the pie. The tougher news is that it just isn’t easy to get a grip on the problem of debt and begin solving it.
Consumer debts like credit cards are usually the highest-cost debt people have, and falling behind can really hurt. We want to help, so below are two different tried-and-true methods for getting out of debt. Neither is a “quick fix” – both take time and discipline. Assuming you’ve got more than one debt to pay off, which method of debt repayment should you use?
The Snowball Method
The snowball method works as follows:
Rank your loans from smallest balance to largest balance.
Pay above the minimum on the loan with the smallest balance. Pay the minimum balance on all your other loans.
When the smallest debt is paid off, take everything you were putting toward the account and add it to the payment for the loan with the next lowest balance.
Repeat the process until you’ve paid all debts.
The Avalanche Method
The avalanche method works as follows:
Rank your loans from highest interest rate to lowest interest rate.
Pay above the minimum balance on the loan with the highest interest rate. Pay the minimum balance on all your other loans.
When the debt with the highest interest is paid off, take everything you were putting toward the account and add it to the payment for the loan with the next highest interest rate.
Repeat the process until you’ve paid all debts.
Which Method Wins Out?
As you can see from above, both the snowball and avalanche methods are similar in that they have you focus on a particular account while paying the minimum on all others. And when you’ve paid off one account, you redirect whatever money you allocated for it to the next one.
But when you do the math, the avalanche method usually will get you out of debt faster. That’s because you reduce the amount of interest you pay on the loan. For this reason, the bulk of money gurus tell people to attack high-interest accounts first.
But here’s the catch. For some individuals, it’s incredibly hard to stay motivated to stick to a debt repayment plan because they don’t feel the gratification that comes with being done with accounts. There’s some solid science behind this. Dopamine is a natural hormone that not only keeps people looking for new information and answers (motivation), it also helps them feel happy. The brain releases dopamine in anticipation of reward. So in theory, having multiple zero balances to look forward to along the way can make it easier to stick to a debt repayment plan.
Ultimately, which technique you use is your personal decision. Just be honest about your situation and habits and pick the strategy with which you feel most comfortable. Most of all, start now. The sooner you do, the sooner you will breathe easier.