Avalanche, Snowball or Consolidation?

Tackling debt can definitely be a daunting task. The bigger the debt, the more daunting. Let’s examine 3 methods to tackle debt: avalanche, snowball or consolidation.

First Thing First

Before choosing a method, you first need to list all the debts you have. This requires being honest and actually face your debt. You’ll also need the interest rate on each debt, the payment amount, when payment is due and the amortization period -if applicable-.

Here is a non exhaustive list of debt examples:

  • Car loan
  • Personal loan
  • Student loan
  • Outstanding credit card balances
  • Outstanding line of credit balances
  • Arrears, e.g. tax or any bill
  • Deferred payments -buy now pay later purchases-
  • IOUs to family and friends

Your mortgage -if you have one- would normally not be included in the above list. Mortgages are long-term, secured debt. You should only pay off your mortgage if you don’t have any other debt, if you have a fully funded emergency fund and max-out retirement contributions each year.

Once you have all this info, tally the total minimum amount of money you require to service your debt each month.

Then, examine your income and expenses to determine the extra amount you can redirect to debt repayment. Only making minimum payments won’t tackle your debt.

Avalanche Method

the “avalanche method” focuses on paying the loan with the highest interest rate loans first. With this method, you direct the bulk of your debt repayments to the debt carrying the highest interest rate. You only make the minimum payment on your other debts.

Let’s say the monthly amount you can allocate to your debt repayment is $ 500.00, and you carry balances on 2 credit cards. 1 card has a 24.99% interest rate and the other 19.99% .

Under the avalanche method, you would only make the required minimum payment on the card at 19.99% and the rest would go to the card at 24.99%. Once you paid off the balance on this card, you would redirect your payment towards the card at 19.99%.

The avalanche method minimizes the amount of interests you’ll pay on your debt, however it could take a certain amount of time before you’re debt-free. The avalanche method makes progress slower and it could be discouraging at times.

Snowball Method

Under the “snowball method”, you start repaying your smallest debt, regardless of interest rate. Let’s assume the monthly amount you can allocate to your debt is still $ 500, and that your smallest debt is $ 300.

You would make one payment, and boom you’re done with that particular debt! The rest of the money would go to make minimum payments on your other debts. The following month, you move to the next smallest balance, and so on.

The main advantage of the snowball method is that you can see your progress faster. It’s more encouraging. However, you may end-up paying way more interests.

Debt Consolidation

As indicated in its name, under debt consolidation, you consolidate all your debt into one. The advantages of doing this is that you have a single payment and you save on interests. The interest rates on consolidation loans are lower. Consolidation is easier for your monthly budget.

The downsides of debt consolidation is that you may not qualify for a consolidation loan. You may also not be able to include all your debts in the loan. If you don’t qualify for a loan, see if you can use a line of credit instead.

As a last resort, you could refinance your mortgage, if you’re a home owner, but it’s not something I personally recommend. You’re rolling unsecured debt into a secured one. You could loose your home if you default on your mortgage. This won’t happen if you default on your credit card payments.

In order for your debt consolidation to work, you need to close the accounts you’re consolidating in the first place. It’s more common than not for people who consolidate their debts to be back to square one debt-wise.

Final Word

Paying off debt requires commitment and discipline. It also requires a change of mindset, once you’re debt-free.

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