Introduction:
The burden of debt has recently become a prevalent concern for many Americans, spurred by the continuation of student loan payments and the increased reliance on credit cards amid rising inflation. In this essay, we will delve into two widely recognized strategies for debt repayment—the debt snowball method and the debt avalanche method—aiming to provide clarity on the best approach for individuals navigating their journey toward financial freedom.
Understanding the Methods
Both the debt snowball and debt avalanche methods presuppose surplus funds for debt repayment and the existence of multiple debts characterized by varying interest rates and payoff amounts.
Debt Snowball Method
The debt snowball method entails making minimum payments on all loans while allocating any additional funds to the smallest loan. Once the smallest loan is repaid, the freed-up monthly amount is then added to the minimum payment of the next smallest loan. This process is repeated until all loans are settled. Borrowers facing the debt portfolio in Figure 1 who follow the debt snowball method would apply extra funds to the auto loan first, followed by the credit card, and then the student loan.
Debt Avalanche Method
The debt avalanche method also involves making minimum payments on all loans. However, the extra funds are directed toward the loan with the highest interest rate. After the repayment of the highest-interest loan, the monthly payment amount is redirected to the loan with the next highest interest rate. This cycle continues until all debts are extinguished. Borrowers facing the debt portfolio in Figure 1 who follow the debt avalanche method would apply extra funds to the credit card first, followed by the Auto loan, and then the student loan.
Comparative Analysis
Using the data from Figure 1, I calculate both the cumulative interest paid over the entire lifespan of all loans and the length of time (in months) required to settle all debts. This methodical approach allows me to determine which repayment strategy not only expedites the elimination of debt but also represents the most economical option in terms of minimizing interest payments.
Figure 1: Household Consumer Debt Characteristics
| Amount | Interest Rate | |
| Credit Card Debt | $30,000 | 21.00% |
| Student Loan Debt | $35,000 | 5.80% |
| Auto Loan Debt | $25,000 | 6.63% |
| Total | $90,000 |
Comparison of the Debt Repayment Methods
Figure 2 compares the total interest paid over the life of all the loans, the time it would take to pay off the first loan, and the total time to pay off all loans. Panel 1 shows that if only the minimum monthly payments are made, then the borrower will pay $35,464.72 in interest over the life of the loans. Further, if the minimum payments are made, it would take 60 months until the first loan was paid, and 78 months until all loans are paid.
Figure 2: Comparison of Debt Repayment Strategies
| Total Interest Paid | Months to First Loan Payoff | Months to Payoff | ||
| Panel 1: Minimum Payment Only | $35,464.72 | 60 | 78 | |
| Panel 2: Snowball | ||||
| $100 Extra per Month | $ 33,008.23 | 49 | 72 | |
| $200 Extra per Month | $ 30,612.79 | 41 | 67 | |
| $300 Extra per Month | $ 28,426.17 | 35 | 62 | |
| $400 Extra per Month | $ 26,473.72 | 31 | 58 | |
| $500 Extra per Month | $ 24,742.60 | 28 | 54 | |
| Panel 3: Avalanche | ||||
| $100 Extra per Month | $ 30,043.34 | 56 | 70 | |
| $200 Extra per Month | $ 26,259.42 | 47 | 64 | |
| $300 Extra per Month | $ 23,466.23 | 40 | 59 | |
| $400 Extra per Month | $ 21,294.96 | 36 | 55 | |
| $500 Extra per Month | $ 19,544.35 | 32 | 52 | |
| Panel 4: Difference | ||||
| $100 Extra per Month | $ 2,964.89 | 7 | 2 | |
| $200 Extra per Month | $ 4,353.37 | 6 | 3 | |
| $300 Extra per Month | $ 4,959.94 | 5 | 3 | |
| $400 Extra per Month | $ 5,178.76 | 5 | 3 | |
| $500 Extra per Month | $ 5,198.25 | 4 | 2 | |
Panels 2 and 3 show the outcome of the snowball and avalanche methods, respectively, when borrowers pay more than the minimum payments each month. By increasing the minimum payments by just $100 each month, the snowball method reduces the interest payments over the life of the loan by approximately $2,456, while the avalanche method saves $5,421 compared to making the minimum monthly payments. In addition to saving money on interest payments, adding an additional $100 per month also results in paying off the loans faster. Specifically, the snowball method would reduce the time to pay off the first loan by 11 months and reduce the time to pay off all the loans by six months. Alternatively, the avalanche method reduces the time to pay off the first loan by only four months but reduces the time to pay off all loans by eight months.
The main advantage of the snowball method is illustrated by comparing the months to first loan pay off in Panels 2 and 3. Focusing on the smallest loan first results in paying off the first loan faster. Completely paying off the first loan in a relatively short amount of time can motivate borrowers to continue their debt repayment plan. Comparatively, borrowers who use the avalanche method may lose motivation when it takes longer to pay off the first loan.
For comparison, Panel 4 shows the difference between the snowball and avalanche method. This highlights the main advantages of the avalanche method. Specifically, lower interest payments and becoming debt-free faster. The bottom row of the table shows that if an additional $500 is added to the minimum payment, the avalanche method will cost $5,198 less in interest payments than the snowball method. Additionally, paying $500 extra per month results in the Avalanche method shortening the time to becoming debt free by two months relative to the snowball method.
Conclusion
While the exact benefits of each debt repayment strategy will depend on the interest rates, amounts, and maturities of loans, the example in this article illustrates the costs and benefits of the debt snowball and avalanche methods of debt repayment. Both methods significantly reduce interest and payoff time with additional monthly payments. The snowball method offers immediate wins, fostering motivation through the early payoff of smaller loans. Conversely, the avalanche method, while requiring more patience for the initial payoff, proves to be more cost-effective, resulting in substantial interest savings and a swifter path to financial freedom. Ultimately, borrowers must carefully weigh these considerations to align their chosen strategy with their unique financial goals.
Dr. Scott Jones
Assistant Professor of Finance and Foust Professor of Business
