Avalanche or Snowball: Which is Right for You?

As a new year approaches, it’s common for people to turn their financial focus to overcoming debt. Among Americans who carry debt, a third of their monthly income goes toward paying it off, exclusive of mortgages.

The drain of debt on cash flow has only been compounded by the effects of the pandemic, which has caused a fifth of Americans to revisit their financial plans and make significant adjustments.

If you’re among those looking for a strategic approach debt repayment, weigh the pros and cons of two popular strategies: debt avalanche and debt snowball.

What is debt avalanche?

You’ll focus first on paying off the debt with the highest interest rates, while making minimum payments on all other debts. After paying off one debt, you’ll move on to debt with the next highest interest rate (keeping your total payments the same).

The pros? You’ll save more money long-term by accruing less interest. The cons? This strategy can be discouraging, as it often takes longer to see progress.

What is debt snowball?

You’ll start by paying off the debt with the smallest balance first, while also making the minimum payment on all other debts. After paying off one debt, you’ll move on to the debt with the next smallest balance (keeping your total payments the same).

The pros? This strategy can be motivating, as you’ll often achieve “quick wins” within a smaller period of time. It’s easier to build momentum in response to these tangible accomplishments. The cons? You may end up paying more interest over time, which in turn extends how long it will take to pay off your debt.

How do you choose?

Financial planning is not just about money – it’s also about emotions. Consider setting up a meeting with an advisor to review the mechanics of the different approaches available. From there, you can determine your preference based on your personal values and what motivates you.

Keep in mind certain considerations, as well:

• Your goals. For example, are you looking at buying a home? If so, it might make more sense for you to pay off a car loan equaling, say, $500 per month, rather than paying off a credit card with $200 per month, as a car loan factors in as a qualifier when trying to buy a home.
• Good vs. bad debt. When deciding which debts to pay off more quickly, remember that not all debt is “bad.” Some debt, such as student loans or mortgages, are considered “good” debt. Good debt often has a low interest rate and plays a role in helping borrowers reach other important financial goals. Credit card debt is usually considered “bad,” due to higher interest rates and the fact that it provides little value back to you.
• The market. One of the biggest considerations of the time we’re living in is, of course, the pandemic. While it’s certainly important to continue paying off debt, maintaining money in an emergency fund may be a higher priority to ensure you will have funding in the event of a possible job loss or unexpected illness.

As with most aspects of life, there is not a one-size-fits-all approach to debt repayment. You’ll want to choose the path that aligns with what’s important to you, and stick to that strategy.

Jessica Veitch is a Northwestern Mutual wealth management advisor.