Dubai: While trying to pay off your debt can seem overwhelming, there are strategies that can help. There are generally two different approaches to take to help pay down your debt.
However, both these methods has its perks and risks. There is no right or wrong answer when it comes to which method is best because every person’s debt situation differs.
Sometimes it might even be a combination of both methods. It is up to you to determine what motivates you and which process may be the best fit for your situation.
‘Snowball’ versus ‘Avalanche’ method: What to know about them
‘Snowball’ method, simply put, means paying off the smallest of all your loans as quickly as possible. Once that debt is paid, you take the money you were putting toward that payment and roll it onto the next-smallest debt owed.
Ideally, this process would continue until all accounts are paid off. As you roll the money used from the smallest balance to the next on your list, the amount ‘snowballs’ and gets larger and larger and the rate of the debt that is reduced is accelerated.
‘Avalanche’ method focuses on paying the loan with the highest interest rate loans first. Similar to the other method, when the higher-interest debt is paid off, you put that money toward the account with the next highest interest rate and so on, until you are done.
By focusing on the loans that are the most expensive to carry, in the long run, would effectively mean you should pay less over time with this method, as it addresses high interest first.
You may save some money with this method, but if the total borrowed amount is large, the time it may take to pay off debt with the highest interest can be discouraging and make it difficult to stick to the plan.
Paying off small debts quickly can feel rewarding. If you prefer to see progress quickly and work your way up, then the first method may be a better fit for your debt management goals.
How to put the different methods to work
To apply these two methods to your financial situation, get organised by following these steps: Firstly, organise any payment information, total amount owed, minimum monthly payments and due dates.
When it comes to the ‘Snowball’, the next step is to arrange your list of accounts from smallest to largest amount owed. On the other hand, when it comes to ‘Avalanche’, arrange your list of accounts from the highest interest rate to the lowest interest rate on each bill.
When it comes to the ‘Snowball’ debt payment method, determine how much extra you can afford to put toward the monthly minimum payment for your smallest debt, or in the case of ‘Avalanche’ method your highest interest rate account, after paying minimum payments on all other outstanding debts.
Remember, if you do not have enough for even the minimum on each of your debts, it can hurt your credit score. For ‘Snowball’, when you’ve paid off the smallest debt, take the money previously used — the monthly payment and the little extra you budgeted — and put it toward the next-smallest debt.
But with ‘Avalanche’, when you’ve paid off the account with the highest interest rate, take the money previously used — the monthly payment and the little extra you budgeted — and put it toward the next-highest interest rate account debt.
• Stay up-to-date on all of your current bills: Don’t start either of the method if you are late on payments, as this will only complicate your debt situation. Contact your lenders to discuss possible options to prevent late payments such as adjusting the payment due date.
• Track your spending: Be careful to not charge up additional debts while you are working to pay down your debt. Track your spending to ensure you stick to your budget. Take note on how your credit score changes. Paying down your debts may help improve your score over time.
‘Snowball’ or ‘Avalanche’ method: Which is better?
A scenario when the ‘Avalanche’ debt method will make your money go the furthest:
Let’s say you have Dh3,000 extra to devote to debt repayment each month. Assume you have the following debts:
• Dh10,000 credit card debt at 18.99 per cent yearly interest rate
• Dh9,000 car loan at 3.00 per cent interest rate
• Dh15,000 student loan at 4.50 per cent interest rate
In this scenario, the ‘Avalanche’ method would have you pay off your credit card debt first, then allow you to pay off your remaining debt in 11 months, paying a total of Dh1,011.60 in interest. The ‘Snowball’ method would have you tackle the car loan first, becoming debt-free in 11 months, but you would have paid Dh1,514.97 in interest.
Just by switching the order of your debts, you can save hundreds of dirhams in interest. For individuals with larger amounts of debt, the ‘Avalanche’ method can also reduce the time it takes to pay off the debt by a few months.
A scenario when the ‘Snowball’ debt method will make your money go the furthest:
Let’s say again you have Dh3,000 extra to devote to debt repayment each month and assume you have the following debts:
• Dh10,000 credit card debt at 18.99 per cent yearly interest rate
• Dh9,000 car loan at 3.00 per cent interest rate
• Dh15,000 student loan at 4.50 per cent interest rate
The ‘Snowball’ method would have you focus on the car loan first because you owe the smallest amount of money on it. You'd settle it in about three months, then tackle the other two. As with the ‘Avalanche’ method, you'd become debt-free in about 11 months.
However, you would have paid Dh1,514.97 in interest – about Dh500 more overall.
Key takeaways
With the ‘Snowball’ method, you will enjoy those little wins and use them as motivation to keep going. If you are analytical and patient, the second method may be the method for you.
With the ‘Avalanche’ method, it may take longer to roll over to your next account but if you have larger balances with higher interest rates and you stick to the plan, it should save you in the long run.
Either way, it will take time, but the important thing to remember is to commit to a goal and stay with it. By staying focused on your end goal, and keeping control over not adding unnecessary new debts, your existing debts will slowly melt away.
Both the methods are types of accelerated debt repayment plans, essentially ways of speeding up the retirement of your debts, by paying more than the minimum due on them each month. Of course, both assume you can afford to commit extra funds to pay down what you owe on a regular basis.
If your income is irregular or unstable, you might want to stick with making minimum payments. If you're applying one of these strategies to credit card balances, they should be credit cards you don't plan to use for new purchases.
Understandably, if debt planners often reiterate that if you continue to persistently amass your debt, you can't pay off a balance – whichever method you use. However, there will most often be special circumstances with certain debts that alter your repayment schedule.
Let’s say you signed up for a credit card with a 0 per cent interest rate for 18 months and used it. Whatever debt repayment method you're using, you'd definitely want to clear this balance before the special introductory rate period ends – regardless of how it compares to your other bills.
Otherwise, you'll just have added a fresh pile to your interest-rate-bearing obligations.
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