As of 2021 Q2, Singaporeans are over $324 billion indebted, of which almost 25% (over $80 billion) is from unsecured personal loans for example credit debt, motor vehicle loans, education loans, and personal loans.
When used smartly and responsibly, debt could be a very great tool for the personal finances. However, sometimes we might find ourselves not able to deal with the sheer number of debts and therefore are unsure which is the best order we ought to clear them.
Today, we will explore the pros and cons of two popular means of prioritising payment of multiple debts: Snowball and Avalanche.
What Is The Snowball Method?
Popularised by Dave Ramsey, the Snowball Method suggests clearing the tiniest of the debts first before moving forward the following smallest, and so on.
Here's the best way to apply the Snowball Approach to clearing your debts.
Step 1: List the money you owe from smallest to largest, regardless of interest rate.
Step 2: Make minimum payments on all of your debts except the smallest.
Step 3: Pay off as much as possible in your smallest debt. Once that is repaid, proceed to the next smallest.
Step 4: Repeat until all your debts are paid in full.
The main appeal of this method is it keeps yourself motivated with small, quick wins. Having your smaller debts out of the way can be extremely gratifying, and cuts down on the number of items on your plate so that you can eventually dedicate more focus (and funds) on clearing your larger debts.
However, since you are disregarding rate of interest, you may end up paying more in interest overall as compared to the Avalanche Method.
What Is The Avalanche Method?
Also referred to as “debt stacking”, the Avalanche Method advocates prioritising the highest-interest debt first before working the right path right down to your debt using the lowest interest.
Step 1: List your debts from highest to lowest rates of interest.
Step 2: Make minimum payments on all of your debts.
Step 3: Pay off as much as possible from the debt with the highest rate of interest. Once that is repaid, proceed to the next highest interest rate.
Step 4: Repeat until all of your debts are paid in full.
Mathematically speaking, this method saves you additional time and cash – it's supposed to assist you to repay your financial troubles in a shorter period with less overall interest than the Snowball method.
But the Avalanche method does require more patience, conscientiousness, and discipline while you can't enjoy the short-term motivation of quick wins.
Illustration Of Snowball VS Avalanche Method (With Numbers)
Take the next scenario:
|Debt Type||Amount Owed||Interest Rate (p.a.)||Monthly Min. Payment|
|Credit Card A||$5,000||25%||$250|
|Credit Card B||$2,000||20%||$100|
Imagine that you simply dedicate as many as $2,000 each month to paying off your debts. As your minimum repayment alone accounts for $1,000, this leaves you with an extra $1,000 monthly.
After paying off your monthly minimums, you'd tackle the rest of your debts in the following order:
1. Charge card B
2. Credit Card A
3. Car Loan
4. Renovation Loan
You'll be able to make quick work of Charge card B, bringing you only three outstanding debts instead of four within a mere two months!
With the Snowball Method, you can expect to take 23 months to repay all your debt, paying $2,069 in interest.
After paying down your monthly minimums, you'd tackle your debts within the following order:
1. Credit Card A
2. Credit Card B
3. Renovation Loan
4. Car Loan
With the Avalanche Method, you will probably take 22 months to repay all of your debt, paying $1,910 in interest, but you are only in a position to reach your first milestone after four months rather than two.
This is just an illustration of methods the Snowball and Avalanche methods can lead to different outcomes. The conclusions can vary depending on the actual rates of interest and loan amounts.
Which Method Results in More Success, Based on Academic Studies?
While mathematical rationale says that the Avalanche method should win hands down, reality has proven to be exceedingly irrational.
Assistant professors David Gal and Blakeley B. McShane of Kellogg School of Management conducted a study this year that showed everyone was more prone to stick with their debt payoff plan when they centered on smaller debts first. Within their analysis, they discovered that those who pursued a strategy of “small victories” were more likely to eliminate their entire debt balance than those who did not.
A 2021 study by associate professors at the Questrom School of economic, Boston University also yielded similar findings: reducing the account with the smallest balance tended to achieve the most powerful effect on people's feeling of progress – and therefore their reason to continue reducing the rest of their debts.
While the Avalanche Method might seem the obvious logical choice, most people have found success with the Snowball Method instead, despite theoretically spending more in interest.
Choosing Between Snowball And Avalanche Method
Whether or not the Snowball or Avalanche Approach to debt repayment is much better depends upon your personal personality.
If you're the type of person who needs small victories to keep you inspired, and also you anticipate the satisfaction of striking debts off your list as soon as possible, then the Snowball method may be better for you.
If you're a rationalist who lives your lifetime through the numbers, then your Avalanche technique is a no-brainer – as long as you can remain disciplined enough to play the long game.
Hybrid Snowball-Avalanche Method – The very best of Both Worlds?
That being said, choosing between one method or the other is something of the false dichotomy – there are situations when utilizing principles from both methods could end up being the best answer for you.
For example, within the illustration above, you could decide to clear your debt in the following order:
1. Charge card A
2. Credit Card B
3. Car Loan
4. Renovation Loan
This presents a hybrid strategy that utilizes the Avalanche method at first (clearing off your highest-interest debts first) and also the Snowball method at the conclusion (clearing off the smaller debt amount first).
Regardless which method you ultimately choose, comprehending the benefits and drawbacks of each can help you tailor a method that best fits your requirements – and brings you closer to achieving freedom in the chains of your debts.