Avalanche overview:
Decreases debts faster than Snowball
Saves money compared to Snowball
May take longer to see significant progress
Might be harder to stay motivated
Snowball overview:
Provides a psychological boost via quick wins
Reduces different debts more quickly
More expensive than Avalanche method
Initial impact may seem low
Debt is a critical component of financial planning, and managing it effectively can make a significant difference in your overall financial health.
Whether you're facing credit card balances, personal loans, or a mortgage, finding
an efficient repayment strategy is key to reducing your debt burden. Two widely-used approaches—the Avalanche and
Snowball methods—each offer unique benefits depending on your financial goals and mindset.
In this guide, we'll break down these two popular strategies, helping you determine
which one best fits your needs—whether your priority is saving on interest or staying motivated by seeing quick
progress.
1. What is Debt?
Debt is the act of borrowing money with the agreement that it will be repaid over time, usually with
added interest. It's a financial tool that allows individuals or businesses to make purchases or
investments they otherwise couldn't afford upfront. Debt comes in various forms, including personal
loans, credit cards, mortgages, student loans, and car loans.
Each form of debt serves a different purpose. For example:
-
Credit cards: - Used for everyday purchases with revolving
credit. They often carry high interest rates, especially if balances are not paid off in full
each month.
-
Personal loans: - Typically used for major expenses like home
improvements or debt consolidation. They have fixed repayment terms and interest rates.
-
Mortgages - Long-term loans designed specifically for
purchasing homes. These loans usually come with lower interest rates because they are secured by
the property itself.
While debt can be a useful financial tool, it comes with responsibility. Borrowers must ensure they can
manage the repayments, or they risk falling into financial hardship. The cost of debt includes not just
the principal amount (the money borrowed), but also the interest, which is the fee lenders charge for
borrowing.
Understanding how different types of debt work and how they accumulate interest is crucial to making
smart financial decisions. Poorly managed debt can lead to a cycle of borrowing that's difficult to
escape, while well-managed debt can help build wealth and provide financial opportunities.
2. Is it okay to have debt?
Having debt is a normal part of modern financial life, and it can be a useful tool when managed correctly. Many people take on debt to achieve long-term financial goals, like buying a house or paying for education, which can increase their future earning potential. In these cases, debt is seen as an investment in your future.
There are two primary categories of debt:
-
Good debt: - This type of debt helps you increase your wealth or improve your life in a meaningful way. Examples include mortgages (since homes typically appreciate in value) and student loans (since education can lead to higher lifetime earnings).
-
Bad debt: - This is debt that is used to purchase depreciating assets or non-essential items. Examples include credit card debt for luxury goods or personal loans for unnecessary expenses. Bad debt usually comes with higher interest rates and can be difficult to pay off if not managed wisely.
It's important to remember that debt should be used strategically. Taking on debt for high-value investments like education or property can be a smart move, but accumulating high-interest debt, like credit card balances, can quickly become unmanageable. The key is to ensure that your debt works for you, not against you, by borrowing within your means and focusing on paying it off as quickly as possible.
A healthy financial approach is to evaluate whether the debt you're considering will improve your future or lead to a burden. If your debt is helping you grow your wealth or providing necessary resources, it can be a beneficial part of your financial life.
3. What is bad debt?
Bad debt refers to any borrowing used to finance non-essential purchases, typically accompanied by high-interest rates. Unlike good debt, which can help you build wealth, bad debt often leads to financial stress and reduces your overall financial security. Examples of bad debt include credit card debt, payday loans, and high-interest personal loans taken out for unnecessary expenses.
Bad debt is dangerous because it can spiral out of control. High interest rates and fees can cause the total amount owed to increase quickly, even if you're making regular payments. If left unchecked, this type of debt can take years to repay and cost significantly more than the original amount borrowed.
The problem with bad debt is twofold:
-
High interest rates: - Credit cards and payday loans often charge interest rates that exceed 20% or more, meaning that a large portion of your payments goes toward interest rather than reducing the principal balance.
-
Non-essential spending: - Bad debt is typically incurred for non-essential purchases, like vacations, luxury items, or dining out, which don't appreciate in value or improve your financial future.
Recognising bad debt is the first step in eliminating it. Focus on paying off these high-interest loans as quickly as possible to avoid further financial strain. While debt consolidation, budgeting, and repayment strategies like the Avalanche or Snowball methods (discussed below) can help, it’s crucial to avoid accumulating new bad debt once you start paying it off.
4. Debt Repayment Strategies
Paying off debt can seem overwhelming, but by using a structured approach, you can steadily eliminate what you owe. Two of the most common debt repayment strategies are the Avalanche and Snowball methods. Both approaches help you gain control of your debts, but they work differently.
With the Avalanche method, you focus on paying off the debt with the highest interest rate first. This method saves you the most money over time since you're eliminating the most expensive debt as quickly as possible. Once the highest-interest debt is paid off, you move on to the next one, continuing this process until all debts are cleared.
Example: Let's say you have three debts:
- Credit card: - £6,000 at 20% interest
- Car loan: - £4,000 at 7% interest
- Mortgage: - £150,000 at 4% interest
Using the Avalanche method, you would focus on paying off the credit card debt first since it has the highest interest rate, while continuing to make minimum payments on the car loan and mortgage. Once the credit card debt is paid off, you would then target the car loan, and finally your mortgage.
The Snowball method focuses on paying off your smallest debt first. By tackling small debts, you gain momentum and motivation as you see those balances disappear quickly. Once the smallest debt is paid off, you move on to the next smallest one, using the psychological boost of quick wins to stay motivated.
Example: Using the same debts:
- Credit card: - £6,000 at 20% interest
- Car loan: - £4,000 at 7% interest
- Mortgage: - £150,000 at 4% interest
In the Snowball method, you would first focus on the car loan because it has the smallest balance. Once this is paid off, you would move on to the credit card, and finally the mortgage, regardless of interest rates. This approach provides motivation by eliminating smaller debts quickly.
Both strategies are effective, but they cater to different financial needs. The Avalanche method is ideal for those looking to minimize the total interest paid, while the Snowball method is better for those who need consistent motivation through small victories. Choose the strategy that aligns with your goals and keeps you on track.
5. The Avalanche method
The Avalanche method is a debt repayment strategy that prioritizes paying off debts with the highest interest rates first. This method is designed to minimize the total amount of interest you pay over time, making it the most cost-effective approach for those who want to save money on interest. By eliminating the most expensive debts first, you reduce the overall cost of borrowing, even if progress might seem slow initially.
Similar to the Snowball method, you continue making minimum payments on all of your debts. However, any extra money you have should be directed toward the debt with the highest interest rate. Once this high-interest debt is paid off, you move on to the next debt with the highest interest rate, and so on. The goal is to reduce the financial burden caused by accumulating interest as quickly as possible.
The biggest advantage of the Avalanche method is that it saves you money in the long run. By targeting high-interest debts first, you reduce the total amount of interest paid, which can significantly lower your overall repayment costs. This method is ideal for those who are financially disciplined and are looking to optimize their debt repayment plan to be as efficient as possible.
However, one of the potential challenges with the Avalanche method is that it may take longer to see results compared to the Snowball method. If your highest-interest debt also has a large balance, it might take time before you fully pay it off and move to the next debt. This lack of early wins can be discouraging for some, making it harder to stay motivated.
The Avalanche method is best suited for people who are focused on minimizing costs and are less concerned with quick wins. If you're more interested in reducing the total interest you pay rather than seeing immediate progress, this method will help you become debt-free in the most financially efficient way possible.
Here's an example to illustrate how the Avalanche method works:
- Step 1: List all your debts in order of interest rate, starting with the highest.
- Step 2: Make minimum payments on all your debts.
- Step 3: Apply any extra funds to the debt with the highest interest rate.
- Step 4: After paying off the highest-interest debt, focus on the one with the next-highest rate.
- Step 5: Continue this approach until all debts are paid off, targeting the highest-interest debts first.
6. The Snowball method
The Snowball method is a debt repayment strategy where you focus on paying off your smallest debts first, regardless of their interest rates. This method is based on the idea that small wins will help build momentum, encouraging you to stay motivated as you tackle larger debts later.
With the Snowball method, you continue to make minimum payments on all your debts. However, you put any extra money towards the debt with the smallest balance first. Once that debt is paid off, you take the money you were putting towards it and apply it to the next smallest debt, and so on. As each debt is eliminated, the amount you can contribute to the next one "snowballs," allowing you to pay off debts faster over time.
This method provides a psychological boost, as you get to see progress quickly. By knocking out small balances early, you gain a sense of achievement that can keep you motivated, even when larger debts remain. This emotional benefit is one of the key reasons why many people find the Snowball method more sustainable over the long term.
However, there is a downside: since the Snowball method doesn't prioritize interest rates, you may end up paying more in interest overall compared to other strategies. If your higher-interest debts are left to grow while you focus on smaller balances, the extra interest accrued could increase the total amount of money you spend repaying your debts.
The Snowball method is best suited for individuals who need quick wins to maintain motivation. It's particularly useful for people who feel overwhelmed by the size of their debts or who struggle to stick to a debt repayment plan when progress is slow.
Here's an example to illustrate how the Avalanche method works:
- Step 1: List all your debts from smallest to largest balance, regardless of interest rates.
- Step 2: Make minimum payments on all your debts.
- Step 3: Direct any extra funds toward paying off the smallest debt first.
- Step 4: Once the smallest debt is paid off, move on to the next smallest debt.
- Step 5: Repeat the process, allowing your payments to "snowball" as more debts are eliminated.
7. Deciding between the two approaches
If your goal is to save the most money on interest, the Avalanche method is the better option. If you're more motivated by quick wins and seeing results, the Snowball method may be the way to go. A hybrid approach is also possible—start with small debts to build momentum and shift to higher-interest debts later.
Both the Avalanche and Snowball methods can help you eliminate debt, but choosing the right one depends on your priorities—whether saving money on interest or maintaining motivation with quick wins. Consistency is key, so choose the method that fits your lifestyle and stick to it.
Before deciding on a repayment strategy, ensure you have an emergency fund in place to cover unexpected expenses. You might also want to explore debt consolidation as an option to combine multiple debts into one with a lower interest rate.
8. Avalanche or snowball calculator
Use our debt repayment calculator to compare the Avalanche or Snowball method. Simply enter your debts, interest rates, and monthly payment amounts to see the impact of each method.
Coming soon.