Debt Stacking (Snowball)
There is much debate in the financial world about which debt payment system is the "right way". Many claim the snowball method is the best while others state the debt avalanche is better.
This argument causes confusion among many in the public who simply just want their debt paid off quickly. So which is better?
That is a loaded question because as with any financial questions, it depends on the person.
Debt Snowball is mathematically wrong when it comes to having the debt paid off faster than other methods.
Stacking interest rates from highest to lowest and paying additional on the debt with the highest rate while paying the minimum payment on the lowest
debts with interest rates do mathematically pay off debt the fastest.
This begs the question, "Why use the debt snowball method then?" Terrific question and it boils to one's psychology. If one is disciplined enough and have the resources, then it is recommended to stack the debt from highest interest rates to the lowest and slowly tackle your debt.
Here is the scenario. Person A has $25,000 in debt. He has 2 credit cards with 14% and 18% totaling $8,000, 1 consumer loan with an interest rate of 7% and a balance of $12,000, and a $5,000 debt with an interest of 9%.
By placing his debts from highest interest rates to lowest, it looks like this:
Earlier I mentioned psychology plays a role. If our guy pays these debts in this order and has the income to do so, he can quickly pay off this debt.
Where the Debt Snowball comes into play is the visual aspect of one seeing debt being eliminated one-by-one. This creates a motivation factor. Below our Person B is paying debts from Lowest Balance to Highest Balance.
In this scenario, she can quickly pay off the $500 by focusing extra payments on it while applying minimum payments to the other debt. Within a month or two, she will no longer have this $500 debt and can apply this payment to the next lowest debt.
This method then creates a snowball effect as the payments for one particular debt gets larger. Seeing debt being quickly knocked off inspires and motivates the person in debt to keep going.
When it comes to paying off debt, you need to determine which method best works for you. There is no right or wrong approach because paying off debt, which is the end result, is always a WIN!