When it comes to paying off debt, there are two popular methods for using compounding interest to your advantage: the snowball method and the avalanche method. Both methods are effective, but they have different approaches and work better for different situations. In this blog post, we’ll explore the differences between the two methods and help you decide which one is better for you.
Snowball Method
The snowball method involves paying off your debts from smallest to largest, regardless of interest rate. The idea is to focus on small victories in order to build momentum and keep yourself motivated. As you pay off each debt, you can use the money that would have gone toward that debt to pay off the next one.
For example, let’s say you have three debts: a credit card balance of $1,000 with a 20% interest rate, a car loan of $10,000 with a 6% interest rate, and a student loan of $20,000 with a 4% interest rate. Under the snowball method, you would pay off the credit card first, then the car loan, and finally the student loan.
The snowball method can be effective for people who need quick wins to stay motivated. It can also be helpful for people who have several small debts with different interest rates, as it can simplify the payment process.
Avalanche Method
The avalanche method involves paying off your debts from highest to lowest interest rate. The idea is to save as much money as possible on interest payments. You make the minimum payments on all your debts, then put any extra money you have toward the debt with the highest interest rate.
Using the same example as before, under the avalanche method, you would pay off the credit card first, then the student loan, and finally the car loan.
The avalanche method can be effective for people who are focused on saving as much money as possible on interest payments. It can also be helpful for people who have large debts with high interest rates, as it can help them save a significant amount of money in the long run.
Which Method is Better?
Both the snowball method and the avalanche method are effective, and the best method for you depends on your personal goals and financial situation. If you need quick wins to stay motivated, the snowball method may be the best choice. If you want to save as much money as possible on interest payments, the avalanche method may be the better option.
Ultimately, the most important thing is to create a plan for paying off your debt and stick to it. Whether you choose the snowball method or the avalanche method, the key is to be consistent and make payments on time. By using compounding interest to your advantage, you can pay off your debt faster and achieve financial freedom.