How to Pay Off Online Loans Using the Debt Snowball and Avalanche Methods

If you took on more debt during the pandemic, you wouldn’t be alone. According to Experian’s latest Consumer Debt Study, total consumer debt balances jumped by 5.4% in 2021, reaching an outstanding $15.31 trillion shared by U.S. households.

The study, which analyzed credit reports collected by Experian, found the average person carries $96,371 across all consumer debts, including mortgages, student loans, credit cards, and short-term personal loans.

Carrying any amount of debt may put pressure on your finances, so Experian’s study suggests there could be trouble ahead. Increasing your debt can tie up cash you might need as rising inflation, the Russo-Ukraine war, and wage stagnation spreads your budget increasingly thin.

How can you put a dent in your debt when current events conspire against your budget like this?

If you’re ready to say ‘sayonara' to personal loans and credit card bills, two basic strategies can help you make a debt-free future a reality: the debt snowball and avalanche. These methods can help you eradicate unsecured debt with purpose.

What Is the Debt Snowball?

The debt snowball method prioritizes paying off the account with the smallest outstanding balance before moving up the chain of debt. Many financial advisors favor it because it promises the quickest results.

It earns its name because it harnesses the momentum of little payments to grow until you can take out big debt. Just like a snowball that grows bulkier as it rolls downhill, your debt payments increase in size as you move through your loans.

How do you make a snowball? Here’s a step-by-step guide:

Step One: First, you must list all your outstanding unsecured debt that doesn’t include a mortgage. You’ll focus instead on any lines of credit, credit cards, or short-term personal loans.

Step Two: Once you have this list, order them by outstanding balance from smallest to largest.

Step Three: Make sure you can cover the minimum monthly payment for every account on your list. If you aren’t sure how you can afford to hit all these minimums, follow this budgeting guide to control your spending and prioritize online loan payments. It goes over common budgeting styles such as the envelope and 50/30/20 budgets for direction.

Step Four: Pick the account with the lowest balance as your focus and put your extra cash towards it on top of its monthly minimum. Stick with this step until you pay off this account.

Step Five: Choose the next lowest balance. Now that you’ve paid off the first account, you can roll in what you put towards it (i.e., the extra cash and its monthly minimum) into the second smallest account.

Step Six: Repeat steps three to five until you move through all your debt. Your extra cash will gain debt-paying powers as you climb up through your accounts.

Why Do People Follow the Snowball Method?

Financial advisors champion the snowball method because it celebrates small wins, and these victories can help you stay motivated.

By prioritizing the smallest balance first, you’ll see results faster. Seeing your hard work pay off helps you stick with your plan to eliminate your credit card and short-term personal loan debt.

Are There Cons to the Snowball Method?

Like anything in life, there are two sides to every coin. While the snowball method promises faster results, it’s usually the more expensive way to pay off debt.

The snowball method fails to consider the cost of the Annual Percentage Rate (APR). APR includes interest and finance charges applied to any credit card or short-term personal loan, and it causes your loan principal (or the amount you borrowed) to grow over time. The higher your APR is, the more you’ll accrue.

But just how much does borrowing at higher APRs cost you? The standard equation to determine the daily APR rate is as follows:

Daily Rate = [APR / 365] X Outstanding Balance

Assuming you have a balance of $5,000 with the average credit card APR of 16.25%, you would pay roughly $2.22 each day in interest and fees.

Now, let’s consider a line of credit for bad credit with an APR of 40%. The same $5,000 balance will cost you roughly $5.48 each day.

The daily differences between these APRs are relatively minor. It’s about the same as upgrading a small cup of coffee to a large one at Starbucks.

Their real danger lies in their compounding effects. Over a month, the card with 16.25% APR would accrue $68.82 in charges, whereas the other account would cost you $169.88. These charges would roll into the next month’s balance, which would increase how much interest you earn in the next statement.

What Is the Debt Avalanche?

The debt avalanche method flips the snowball strategy, switching from balances to interest rates. You’ll focus on paying down the account with the highest interest rate or APR to control how much interest you accrue over time.

Here’s how you can follow this method:

Step One: Once again, list your unsecured debt, ordering accounts by biggest APR to smallest APR.

Step Two: Ensure you can pay the monthly minimums on every account on your list. Refer to your budget to make sure you hit this target.

Step Three: Focus on the account with the biggest APR first. You’ll want to put any extra cash towards this account until you pay it off completely.

Step Four: Moving onto the next highest APR, you’ll want to roll in what you were paying towards the first account (any extra cash and its monthly minimum) and put it towards the second account, plus its monthly minimum.

Step Five: Rinse and repeat until you move down your list until you move down your entire list.

Why Do People Use the Debt Avalanche?

The avalanche method’s biggest perk is that it knocks out the account earning the most interest first, so you’ll accrue less interest overall. In other words, the avalanche method is the option that will save you money over time.

Are There Cons of the Debt Avalanche?

No strategy is flawless. The avalanche’s biggest downside is how much time it takes you to pay off your debt.

There’s a good chance that the account with the highest APR is also the account with the biggest balance. If you can only put small windfalls towards this account, it may take months or even years to make a dent in your first account.

This slow-burn technique is cost-efficient but can be hard to stick with because you won’t have quick, small victories to celebrate.

Which Method Should You Choose?

Although an avalanche is more cost-efficient, a snowball can keep you motivated and on track. It’s up to you to decide which one of these perks is more valuable.

It’s easy to agonize over your decision, which only delays your start to paying off what you owe. Remember, you can always start with one and switch to the other if things aren’t working.

The same policy goes for the budgeting method you choose to help you commit to extra payments. You can experiment with other styles until you find one that works.

Savings Tips to Help You Commit to Your Method

However, you choose to pay off debt, your next challenge is finding extra cash in your budget to make one of these methods a reality. Here are some simple ideas to help you get started.

  • Put Monthly Subscriptions on Hold: It’s easy to collect subscription boxes and streaming services without realizing how much they cost altogether. Take stock of your subscriptions and edit this list down to the one you use the most.
  • Work out at Home: The average gym goer spends $58 on their monthly membership. That’s more than $600 a year. Switch to a free at-home workout to use that cash for debt.
  • Organize Your Meals & Grocery Shopping: You can control grocery inflation by planning your meals around cheap ingredients and store flyers. Download the latest coupon and rebate apps to lower your bill and earn cashback when you shop.
  • Reduce Transportation Costs: It’s never been more expensive to fuel up, so you’ll want to reduce how often you get behind the wheel. Try carpooling or taking transit if possible. Otherwise, seek out the cheapest gas station and capitalize on loyalty cards to earn points on every gallon.
  • Downgrade Your Internet & Phone Plans: Research Internet and phone plans to find the cheapest options. You can save a lot by limiting your data or using prepaid contracts.
  • Go Dry: Happy hour after work and wine with dinner can add up.

Bottom Line:

You can collect debt until it takes a large bite out of your monthly budget, leaving you with less money to enjoy life or sock away in savings. Without savings as backup, you’re more likely to add to your debt when an unexpected expense costs more than you can afford with your cash on hand.

Ready to break the cycle? It’s time to choose between the snowball and avalanche methods. One will help you knock out your first loan fast, while the other reduces how much interest you’ll accrue.

Choose the strategy that works for your financial goals today; whichever you decide, these tried-and-true strategies provide a plan of attack for paying off what you owe.

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This article was produced and syndicated by Wealth of Geeks.