Debt Repayment: Snowball vs. Avalanche

It’s no secret that managing debt is one of the most commonly faced financial planning issues. In fact, Canada currently has the highest level of household debt to disposable income of any G7 country.

We often get asked what the most effective way to repay debt is. There are two popularized strategies for debt repayment that we’ve seen be very effective, they are analogously thought of as “The Snowball Method” and “The Avalanche Method”.

Today’s post will review both strategies to help you make an informed decision on which method will work best for you.

The Snowball Method: A Behavioral Approach

As the name implies, this method can be illustrated by picturing a small snowball rolling down a hill. The snowball starts off very small, and as it grows it increases in size and momentum.

The Snowball Method prioritizes the psychological momentum gained when eliminating a debt. By focusing on paying off your smallest debt first, regardless of the interest rates, the momentum begins to work in your favour. From there, you can move onto repaying the next lowest amount owed with increased cash flow and growing momentum.

Here’s how it works:

1. List Your Debts: Order them from smallest to largest balance.

2. Make Minimum Payments: Continue to make minimum payments on all your debts except the smallest one.

3. Focus on the Smallest Debt: Put any extra money toward the smallest debt until it’s paid off.

4. Move to the Next Debt: Once the smallest debt is eliminated, move on to the next smallest debt, and so on.

Behavioral Perspective: By quickly paying off your smallest debt, you experience a sense of accomplishment and financial control, which can provide motivation to tackle larger debts like a mortgage.

The Avalanche Method: A Mathematical Approach

This strategy is conceptually similar to an avalanche as a small amount of snow falls down the top of the hill and grows in impact as it moves faster and faster downhill.

By implementing the Avalanche Method of debt repayment, you prioritize debt repayment based on the interest rates rather than the balances. As you cross-off the most expensive debt, you can free up more cash flow to attack the next highest-interest debt.

Here’s how it works:

1. List Your Debts: Order them from the highest to the lowest interest rate.

2. Make Minimum Payments: Continue to make minimum payments on all debts except the one with the highest interest rate.

3. Focus on the Highest Interest Debt: Put any extra money toward the debt with the highest interest rate until it’s paid off.

4. Move to the Next Highest Interest Debt: Once the highest interest debt is eliminated, focus on the next highest, and so on.

Mathematical Perspective: By targeting the highest interest debt first, you minimize the total interest paid. This method is widely accepted as the mathematically correct approach to debt repayment, however in practice, it may negate the psychological benefits of eliminating that nagging smaller debt first.

Which Method is Right for You?

Snowball Method: This method is best applied to those who would respond positively to motivation and psychological boosts when approaching their financial goals. If you’re the type of person who thrives on small wins and needs that encouragement to stay on track, this method is more suitable for you.

Avalanche Method: This approach is optimal if your primary concern is to minimize the cost of interest and pay off debt as quickly as possible. It’s suitable if you are disciplined and can stay motivated without frequent rewards.

Ultimately, the best strategy is the one that keeps you motivated and on track to achieving your debt-free lifestyle, and there’s nothing wrong with striking a balance between the two in practice.