As was promised, we continue with yet another entry for our Book of Debt. This time we’ll explore another method that might come handy in relieving your financial burden. Contrary to the grand-scale name of ‘avalanche method’, this one is quite petite. If you give it a try, however, it hits just the right spot.
It’s a mere coincidence that the winter theme aligns with these blog topics. Nevertheless, it’s rather fitting.
Last time we touched the subject of repaying your most taxing debts. The debts that would cost you more money if you let them drag out over their scheduled lifetime. Using the avalanche method to rid yourself of these debts is a very effective method. As when you eliminate the highest interest debt, you ‘unlock’ extra funds to help you proceed with your task a lot quicker. This method really works, especially once you get the process rolling down the slope. Get it?
Why would I need another method then?
Indeed, that is the question we’ll try to answer this time. Because, financial strategies can be like crystal slippers in a way – one size could fit all. That is, if you’re ready to lose a toe or develop a severe posture problem.
There can be many reasons why repaying your highest interest debt first could be bothersome for you. For instance, you find yourself in a situation where it’s prudent for you to eliminate the largest loan first, to reduce your total loan balance. That’s typical if your intent is to get a larger loan in the near future – like a mortgage, for example.
It’s also of importance to not disregard the psychological struggle a person might experience when opting for the avalanche method.
See, mostly the high-interest debts also tend to be the smallest in amount. Credit cards and personal loans around the world usually don’t go much higher than €25,000 or equivalent. Compared to student loans, car leasing and mortgages that might only cover a third or less of your total loan amount.
All this means that using the avalanche method can be taxing mentally. As your total loan amount will only decrease significantly if you remain disciplined and put all your additional funds towards the particular debt you’ve started to repay, until you repay it and then move on to the next loan on your list and continue being disciplined.
Truth be told, with your finances, it’s always better to be disciplined and prudent. However, for some, it’s easier said than done. So, why not look for another way?
What is the ‘snowball method’ and how is it better?
The snowball method is a strategy where you repay your debts starting from the smallest amount owed. Once you’re done with the first loan, you move on to the next smallest. Similarly to the avalanche method, once ridding yourself of a debt you use the monthly amount used for that debt to add to the monthly payments of the next smallest debt.
It sounds and works a bit familiar, especially in the long run. You start with a snowball and once you get rolling it grows in strength. You know, just like an avalanche.
The difference with the snowball method is rather simple. You don’t have to do any research whatsoever. There’s no reason to calculate APR for any of your loans, or compare it. All you need to do is pick your smallest loan, and you’re good to go. For example, out of the following:
- student loan – €10,000 with an APR of 2%
- credit card balance – €5,000 with an APR of 19.5%
- personal loan – €2,000 with an APR of 11%
- car leasing – €20,000 with an APR of 2.4%
You would pick the personal loan as the first to repay, then – the credit card balance. With the student loan and car leasing closing out the order. That’s not at all like the avalanche method, is it?
Wait, last time you said that repaying high-interest loans first can save me money?!
Yes. And that still holds true. As you’ve obviously noticed from the example, the snowball strategy doesn’t care for interest rates and APR. The snowball method’s greatest flaw will be that you’ll probably end up paying more money over the full lifetime of the loans.
If your financial situation warrants you to examine your loans thoroughly, establish an order for repayment and save as much money as possible – by all means, you’d be best off with the avalanche method.
The good news is – often the smallest debts tend to be the ones with the highest interest rate anyway. Just like in the example, the two highest APR loans are personal loans and credit cards balances. So, even when using the snowball method you might accidentally strike gold and rid yourself from the most expensive loans first, too. That’s like getting two birds with one.. snowball.
The intended gain from the snowball method, however, is not entirely financial. This method will help you repay a debt faster – so the gain will be more psychological than anything. The gratification from repaying a debt, especially if it’s your first repaid debt after a financial struggle – well, it can be very exhilarating to say the least.
This feeling of exhilaration will feed your motivation to continue on your path towards repaying your debts.
In conclusion – let it go and start with something. Anything.
While picking the right strategy for you might indeed be confusing – it’s important that we’re here, having this discussion. See, you’re already putting your mind to the issue. And, more often than not, it’s as simple as just giving a go.
If you have multiple loans to your name. If you’re struggling financially a little. If you’re afraid that you won’t succeed at climbing out from under the burden of your loans – really, try the snowball method!
This method works very well to start you off on your way. As soon as you see your first loan disappearing, you’ll feel even more motivated than before. Consider that sometimes the smallest loans are the highest interest loans, too. Chances are, while starting with the snowball method, you’ll simultaneously start with the avalanche method. And then go from there – you’ll be glad you did!