So, you’re wondering what icky debt to pay off first. We’ve all been there. You come across a few extra dollars that you prudently decide to throw at your debt so that you can take a stab at lowering that balance that you’ve seen for numerous (maybe countless) months now. You’re fed up with it. You want to grab your financial situation by the horns and take charge!
Well first, my hat goes off to you! Not many folks are willing to utilize any extra dollars they might come across to enhance their financial stability. And chances are that if you’re reading this post, you are at the very least interested in taking steps to improving not only your finances, but your overall fulfillment. I commend you.
So which debt to pay off first? I will try to be short and sweet with my recommendation. As a matter of fact, I will present you with two well-known options that hopefully one will be more up your alley. These two are commonly referred to as the Snowball and Avalanche methods. Let’s break them down.
The Avalanche Method
Let’s start with the one I would recommend: the Avalanche method. Very simply, this method suggests that the debt with the highest interest rate should have the highest priority regardless of the other balances you might have. For example, suppose you have a credit card balance of $5,000 and a student loan of $7,500. The credit card is at a 15% rate and the student loan is at 5%. The simple breakdown below might blow your mind!
As you can see, you would essentially be paying twice the amount of interest per day toward the credit card which, mind you, is 33% less than the student loan! It seems counterintuitive that you would have to pay more for a smaller balance! Thus, my recommendation for striving to pay off the balance with the highest rate first.
The Snowball Method
Now conversely, the snowball method suggest that you first pay off the smallest balance and then work your way up. This method is particularly intriguing because of the positive psychological and emotional effects that it offers. Winning the small battles first emboldens you to take on the next larger obstacle. After paying off that pesky smaller balance, you’re pumping out endorphins that stimulate you to keep on rolling. You feel unstoppable and convinced that you have what it takes to be the chess player and not the chess piece!
As you can see, you will end up saving less per year if you were to pay off the smallest balance. But, the differentiating factor here is the euphoria that you get after overcoming that first hurdle. It ideally works as a domino effect in which the smaller domino continually knocks over the next larger one.
Evidently, the avalanche method will save more money in the long-term. But if feeling good about your accomplishments fuels you to keep powering through in tackling your debt, then by all means, I would encourage the snowball method! The goal is to feel one tangible step closer to financial freedom.
Personally, I have admittedly used a combination of the two in my financial journey. Undeniably, there are times when I would rather see a zero balance on my small $1,000 student loan than to try to get ahead with my car payments without really denting the principal balance.
Interestingly, it may also come down to which side of the brain you relate to the most. Are you the more analytical/rational left side? In that case, paying the balance with the highest interest rate will likely be your ideal approach. Or if you are the more creative/artistic right side, then paying off the smaller balances and bulldozing your way forward would probably be more fitting.
Which method have you used? How has it made you feel? I’d love to know your thoughts!