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Research Proves This is The Best Method to Pay Down Debt

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Research Proves This is The Best Method to Pay Down Debt

If you’re struggling to pay off several debts at once, a group of researchers may have found the best strategy for success.

In the study, which was highlighted in the Harvard Business Review in December, researchers found people who concentrated on paying off just one of several debts before moving on to the others repaid their debt 15% faster than people who consolidated their debts and tackled them all at once.

The researchers, who hailed from Boston University, University of Alberta, University of Manitoba, and Georgetown University, collected anonymous data from more than 6,000 HelloWallet users over 36 months. HelloWallet is an online financial program that allows employees to make financial goals and track their spending and debt payments.

By analyzing the methods HelloWallet users used to pay off their debt — focusing on one small debt at a time or paying all debts at once — the researchers could tell which method worked best.

“Our research suggests that people are more motivated to get out of debt not only by concentrating on one account but also by beginning with the smallest,” Boston University professor Remi Trudel, co-author of the report, told the HBR.

If this strategy sounds familiar, it should. It’s exactly how the popular “debt snowball” strategy works. In this method, the key lies in building momentum early on by achieving small “wins,” paying off tiny debts first and working your way up to larger debts.

When you pay off your first  $200 account balance, you’re more likely to be excited to tackle the credit card with $500 on it, then the card with a $1,500 balance, and so on. Likewise, by focusing on smaller debts, consumers are doing the crucial work of building good financial habits at an early stage. Once those habits become ingrained in their financial picture, they are more likely to keep them up, even as they take on larger debts.

If anything, Havard’s research simply supports why the snowball method is so popular — it really works.

Of course, if you are a fan of the other popular debt payoff methods like the debt avalanche or debt consolidation, this doesn’t necessarily mean you’re on a path to failure. If you have the option to consolidate all of your debts into one single loan at a lower rate (for example, by taking advantage of a balance transfer), math is on your side. By consolidating your debts at a lower interest rate, you will spend less money on interest over time.

However, if your high interest debts also happen to be the largest of your debt balances, you run the risk of getting discouraged early on and losing momentum because it will take so much more time to pay them off. If you are not confident that you’ll be motivated to pay off one large debt balance, you might be better off — as the Harvard study shows — working on your smallest debt first, even if it means paying more interest in the long run.

If you’re still interested in exploring different debt paydown methods, here’s a quick recap of the debt snowball vs. debt avalanche.

The snowball

When you snowball debt, you order all of your debts by balance and prioritize paying off the account with the lowest amount first. The method was made popular by Dave Ramsey and is the approach many use when tackling debt. The hope is that paying off lower balance loans will motivate you to pay off the remainder of the debt.

The avalanche

Mathematicians would likely argue in favor of the debt avalanche method. The avalanche approach has you order your debt by interest rate in order of the balance. Then, you prioritize paying off the account balance with the highest interest rate and attack the rest of your debt that way. The argument for this method is that it saves you money in the long run since you can avoid paying the most interest and will likely address the principal of your debt faster.

If your account with the highest interest rate is also your highest or one of your highest accounts by amount, the “avalanche” could have the opposite effect of the snowball method. It can be difficult to stay motivated if you don’t feel as if you are making much progress, and you could be discouraged early on.


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Debt Snowball Vs Debt Avalanche — Which Strategy Works Best?

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The typical American household carries $15,762 of credit card debt. With the average credit card interest rate hovering around 13.35% today, that means households could easily spend more than $2,000 each year on credit card interest alone.

As more and more interest accrues, paying off what might have once been a relatively small amount of debt can easily start to feel like an impossible feat.

That’s why getting out of debt — especially when you have several different types of debt to deal with — requires a strategy.

Two of the most popular debt payoff strategies out there are the “debt snowball” and the “debt avalanche.” The snowball method has been popularized by personal finance celebrities like Dave Ramsey. By comparison, the debt avalanche is lesser known.

But which method actually works best? We did the math to find out.

Debt Snowball

Senior man playing with snow

First, list your debt from the smallest balance to the largest balance. Your goal is to eliminate the smallest debt first. You accomplish that by making only the minimum payment required on all your other debts. Then, take every extra dollar you have and put it toward the smallest debt. Once it’s paid off, you will throw everything into the next largest debt, plus an additional amount that is equal to whatever the previous debt’s minimum required payment was.

As you move from one debt to the next, you are creating an even bigger “snowball” to tackle your larger debts. That’s because you’re not only paying however much you can afford to set aside each month. You’re also adding to that amount when you add in the minimum required payments for each card that you pay off.

Why it works:

The snowball has two advantages. First, it provides you with a clear plan. Second, you build a lot of positive momentum by achieving wins early on, which will help you keep going. A recent study found most people do better with this approach because of the positive reinforcement of quick wins.

Debt Avalanche

Debt Avalanche - Man Skiing In Winter

To create a debt avalanche plan, list your credit card debt from the highest interest rate to the lowest. Pay the minimum due on all debt except the card with the highest interest rate. Put all extra money toward the most expensive debt until it is eliminated. Once that debt is paid off, take whatever you were paying on that bill and apply it to the next debt on your list, plus the minimum required payment from the debt you just paid off.

Why it works:

By dealing with debt that has the highest interest rates first, you can get out of debt faster and actually save more money on interest in the long run. It can feel more challenging than the snowball method, because you might be facing larger debt balances to start with. But the payoff is how much you’ll save on interest charges.

MagnifyMoney created a calculator that can easily help you see the difference between the snowball and avalanche methods.

Imagine you have three credit cards and can afford to pay $500 a month toward your debt:

  • $2,000 on a credit union credit card with a 6% interest rate
  • $6,000 on a credit card with a 19% interest rate
  • $8,000 on a store card with a 28% interest rate

Using the MagnifyMoney calculator, you see you could save $1,301 by using the avalanche method instead of the snowball method. And that is not surprising: by eliminating high interest rate debt first, you will end up paying less interest overall. You would also be out of debt faster.

The bottom line:

Both strategies will work, but you should pick the one that best fits your personality. If you easily feel overwhelmed by debt and feel like quitting, you should probably try the snowball method. You’ll get early “wins” and feel lots of motivation to keep going. If you’re more disciplined, the debt avalanche strategy might be your best fit.

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Slash Interest Rates and Then Use the Debt Snowball

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The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Very Upset Woman Holding Her Many Credit Cards.

There are two common ways you can focus on debt repayment. The first, known as debt avalanche, makes mathematical sense. You chip away at the debt with the highest interest rates first to minimize the overall damage it can do to your wallet. Then you work your way down. The second, called debt snowball, makes psychological sense. Popularized by the personal finance expert Dave Ramsey, the debt snowball plan encourages you to pay off your smaller debts first, regardless of interest rate, and then use the psychological empowerment to keep motivating your debt repayment journey.

Ramsey refers to the use of the debt snowball as “behavior modification over math.” He’s also anti-credit cards, which makes balance transfers a no-go and even the use of credit cards for regular spending frowned upon. At MagnifyMoney, we understand the rational behind removing the temptation of credit cards, but we also want to see you get out of debt as quickly and efficiently as possible. So, we propose a modification to the traditional debt snowball method.

[Why This Dave Ramsey Fan Still Uses Credit Cards]

The Slash then Snowball Method

You can list your debts in order from smallest to largest, but we’d also encourage you to write the interest rates next to the debts.

Take a look at the largest interest rates. Do you have credit card debt sitting at 20+ percent?

$5,000 of credit card debt at 20% APR paying only $250 a month will take you over two years to pay down and cost you $1,131 in interest.

Multiple credit cards at high interest rates will likely cost you hundreds to thousands of dollars over the course of your snowball repayment journey. It’s prudent to get at those high interest rates as fast as possible. But that would mean you’re doing the debt avalanche instead of debt snowball.

Instead, here is a twist on the modern snowball method. Don’t focus on the smallest debts alone; also consider slashing the interest rates and then snowballing.

[How Much is the Debt Snowball Method Costing You?]

Slash and Snowball in Action

You have five credit cards you’re trying to pay off. You’ve written the list of your debts from lowest to highest.

  • Credit Card A: $700 – 16% – minimum payment $25
  • Credit Card B: $1,200 – 15% – minimum payment $25
  • Credit Card C: $2,400 – 20% – minimum payment – $50
  • Credit Card D: $2,850 – 18% – minimum payment $85
  • Credit Card E: $3,000 – 16% – minimum payment $100

TOTAL: $10,150 in credit card debt with an average interest rate of 17.00%

Each month, you’re currently paying $285 towards just the minimums. You’ve decided you can afford to pay $350 per month towards your debt.

In the traditional debt snowball method, you’d pay your minimum balances until you’ve paid off the first debt and then take the amount you were paying on the paid off debt and add it to the payment towards the next debt in line.

For example, once you pay off the $700 debt, you’d put that $25 a month you were paying and add it to the $25 a month on the $1,200 debt so you’re now paying $50 a month. Once that’s paid off you add the $50 a month to the $50 minimum on the $2,400 so it’s $100 and so on.

In the slash then snowball method, you first see if you can lower the interest rate on your smallest debt or first few debts. The easiest way to do this would be with a 0% balance transfer offer.

If you were approved for a $2,000 with a 0% balance transfer offer at no fee, you could move your $700 debt and the $1,200 to 0%. You’d then pay $115 a month towards your debt, because you’d be combining both minimums and the extra $65 a month you’re committing to your debt repayment.

By paying $115 per month towards the debt at 0% interest, you could knock down $1900 worth of debt to $150 in 15 months. Even if you paid a balance transfer fee, typically around 3% of the transferred balance, you could’ve knocked down the balance of two debts to $207 in 15 months. Keep in mind, you’re still paying the minimums on the other debts.

Electing to not do the balance transfer and paying $90 a month towards Credit Card A (that’s the minimum plus the additional $65 a month committed to debt repayment) would take 9 months to pay off the $700 and cost $44 in interest. In those 9 months, barely a dent has been made in Credit Card B because you’re only paying the minimum.

Assuming you completed the first balance transfer, the next move would either be to transfer the remaining balance and the balance of the next card (or two) to a new 0% balance transfer offer. Or you could stick with the traditional snowball method and use the $115 per month to pay off the remaining $150 balance in two months and then snowball that $115 to the $2,400 credit card debt. Combine the $115 with the $50 minimum payment, and you’re paying $165 a month.

By forgoing the debt snowball, you could pay off the balance in 17 months and then snowball the $165 to the next debt. But it would cost you $359 in interest.

If you did a balance transfer, like the Citi Simplicity at 0% for 21 months and a 3% fee, it would cost you $72 for the fee and it would be paid off in 15 months.

Who Should Use this Method?

Using balance transfers to help get yourself out of debt faster shouldn’t be used by everyone in debt. If you’ve ended up in credit card debt due to a shopping compulsion or because you’re unable to handle access to credit without spending more than you earn, then stay away from using a balance transfer. Cutting up credit cards would be the best course of action for you. But, if you’re in credit card debt because an emergency happened that you couldn’t afford or you elected to finance a purchase on credit cards and couldn’t pay it down, then the slash before snowballing method could work for you. Balance transfers are an incredibly effective tool, but only if you use them correctly, avoid the traps and commit to paying down your debt and not spending on the cards.

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