Avalanche or Snowball?

Many of our readers are carrying ‘bad’ debt and are looking at ways to get rid of it as quickly as possible (surprisingly, this is not always a good thing) ….

There are two competing methods:

1. Dave Ramsey’s Debt Snowball, and

2. Flexo’s Debt Avalanche.

Actually, neither invented nor ‘own’ their method, they are each just the most recent promoters of their respective method that I could find with a quick Google search.

Followers of Dave Ramsey tout his method as the best because it encourages the smaller debts to be freed up first, hence putting larger and larger amounts towards each succeeding (and larger) debt. The psychological ‘boost’ of the early quick wins (by paying off the small debts first) are said by Dave’s fans to help ride the bigger waves (of the bigger debts) that will then confront you.

Flexo counters with cold mathematical logic:

If you have a certain amount of money available to pay off a portion of your debt each month, even if that certain amount changes, there is a mathematically correct way of paying off that debt. You can call this approach the Debt Avalanche. It is similar to Dave Ramsey’s popular “debt snowball” method, with one small but important detail: With the Debt Avalanche you will pay off your debt faster and pay less total interest to banks and lenders.

I think Flexo is technically right: the people that will give up because they don’t see a ‘quick win’ are probably financially doomed, anyway.

But, I disagree with Flexo in that, for most people the difference in time and cost is probably marginal in the whole scheme of their lives and if it serves to solve their problem (and, for them, the other method won’t) then for me utility wins. But, only if the avalanche won’t work for that person (and, I can’t for the life of me see why it wouldn’t, but whom am I to speak for everybody?) …

However, as far as either method goes – and, this is particularly suited to the method of ordering the debts by interest rate as in the Avalanche method – I would add an important ‘tweak’ here:

I would draw a line where the debt is lower than the cost of a current mortgage and at that point seriously think if I really do want to pay off that low cost debt or would I rather apply the cash towards an income producing investment and allow that older debt to run it’s course.

Student loans are a perfect example of this:

Why pay off a 2% loan in order to then incur a 6% mortgage on a real-estate purchase (assuming that’s what you intend to do next); just put the cash that you were planning to apply to the student loan into the RE and take a lesser mortgage.

Refinance when the student loan falls due (or interest rates increase, as some can ratchet up over time) and use the refinanced cash to pay it off (check out the likely refinance expenses right up front, though, to make sure that this will be cost-effective).

Complicated? Sure … Mathematically effective? Absolutely!

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0 thoughts on “Avalanche or Snowball?

  1. I look at it this way. I first pay the minimum on everything. I keep a specific amount of money to run my businesses, but all of that money has a cost of capital, if not a real cost but an opportunity cost. I then can figure out the cost of that capital. I don’t pay off any of the debt that is below that cost of capital, UNLESS it is money that I can access again if the business needs the capital. I figure that my current opportunity cost/cost of capital is well above 20%. My average debt is only 8% and all of it is below 20%, so I am in the phase where I ONLY pay the minimum to everything. I put the rest to investing in my business. I can buy $5000 in parts and turn it in to $6000 fairly easy and so it would be insane to take this money and use it to reduce debt. I do pay the 5000 on a card and use that card to buy the inventory. 2 years ago I had over 100k that I was investing in such a way and it was producing well over 15k per month, but through a string of theft, and market losses much was lost. I know now that protecting this money is more important than debt reduction.

    Jason Dragon

  2. Makes perfect sense. I don’t know why so many US PF bloggers want to pay off their cheap student loan or mortgage debt so fast.

  3. When I learned about the snowball method I was told the snowball had two methods: you could EITHER pay the biggest amount first OR pay the biggest interest rate first.

    So the ‘snowball’ and the ‘avalanche’ are the same thing. In both of them you are paying the minimum on every debt…except for one debt that you target and pay more than the minimum.

  4. @ Lulugal – If you don’t intend to invest then I agree any method is pretty evenly matched … then again, if you’re not intending to invest, you wouldn’t be reading this particular ‘wealth-building’ blog, either 😉

  5. Pingback: Debt snowballs, avalanches, meltdowns … « How to Make 7 Million in 7 Years™

  6. My interest rates are pretty close to each other so I am pretty much snowflaking right now. Mind you when there were major differences in the the interest rates I was definitely avalanching. Paying more interest than I need to makes me physically ill now.

  7. Pingback: * Dave Ramsey’s Debt Snowball

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