Melt Your Debt Away: Forget the Snowball or Avalanche Debt Reduction Plan

debt reduction - bang for your buckDebt sucks!  If you are working to get out of debt you know exactly what I’m talking about.  There are a ton of debt reduction strategies out there and trying to figure out which one is best can be downright frustrating.

Two Sides of Debt Reduction

There are really two different sides to looking at debt reduction, like there is in anything really…

debt reduction - logic and emotion

Logic and Emotion

Humans are complicated.  We have these things called brains.  But we have two sides to our brain.  We have our right side which is all about emotion.  And then we have the left side responsible for logic.

It’s a good thing, too because without one or the other our world would be a very different place.

Right Brain: Emotion

debt reduction - emotional

First we have the right brain.  Emotion.  Feelings.  Your “heart”.  Or your “gut”.

The right side of the brain is how you react to things.  It’s all about whether it feels right.

Unfortunately, many of us allow our emotions to control our decisions surrounding money.  This is what gets us into the debt situation in the first place.

You see, if you were making decisions logically you would never make the choice to spend 3X more than something costs.  Because that is exactly what happens when you buy something on a credit card that you plan to pay off by making minimum monthly payments.

But, emotions are just a part of being human and we must embrace that.  So, when it comes to getting out of debt we should consider our emotional side and consider a debt reduction strategy that takes our feelings into consideration.  The debt reduction strategy that taps into our emotional side is…

The Debt Snowball

You may have heard of this strategy already but let me summarize it for you real quick as a refresher.

[click_to_tweet tweet=”The Debt Snowball strategy pays off the debt with the lowest balance first.” quote=”The Debt Snowball strategy pays off the debt with the lowest balance first.” theme=”style3″]

Why?  Because it feels, oh so good.

You’re making progress.  It feels like you are getting somewhere.  And you are, but maybe not as quick as you could with another strategy.

Left Brain: Logic

debt redu

 

Next up, the left brain.  Logic.  On or off.  Yes or no.  Right or wrong.

With the left side of the brain it is all about data.  About making the decision that is right.

When it comes to money with your logical brain there is just one right answer to defeating your debt.  Whichever method will pay the least amount of interest in the least amount of time wins.

See, with your left brain it is all about the math.  If the math shows that this provides the “best” result then that debt reduction strategy wins.  Which strategy is that?

The Debt Avalanche

This strategy is not as common as the the Debt Snowball strategy but is the most logical method of defeating debt.

[click_to_tweet tweet=”The Debt Avalanche pays off the debt with the highest interest rate first.” quote=”The Debt Avalanche pays off the debt with the highest interest rate first.” theme=”style3″]

Paying off the debt with the highest interest rate means you end up paying less interest now and over time.  The quicker you can eliminate the highest interest rate debt the less interest you will have to pay.

But Wait…

[click_to_tweet tweet=”Forget about these cold and snowy (snowball and avalanche) methods and instead light the fire and let’s melt your debt away.” quote=”Forget about these cold and snowy (snowball and avalanche) methods and instead light the fire and let’s melt your debt away.” theme=”style3″]

It is the best of both logic and emotion.  It may not be the quickest and lowest interest but it works…for many reasons.

The Debt Snowball method works because you feel like you are making progress.  You pay off the lowest balance and you can see progress.  You freed up your cash flow to pay off the next debt.  But you could end up paying more interest than necessary.

The Debt Avalanche method works because you know that in the end you will end up paying less interest and in a shorter amount of time than with any other strategy.  But what if your highest interest rate balance has a high balance too.  Even more of a logical reason to pay it off first.  But you might have to wait a long time, sometimes years, before you see that first debt paid off.

Here’s my strategy…

I call it the Bang For Your Buck Debt Reduction strategy.  Here is how it works:

Bang For Your Buck

Let’s say you had some extra cash available available to pay off debt.  You are now faced with which debt to apply it towards.  To figure this out you do a simple mathematical (yep, logical brain) calculation.

You calculate your bang for your buck ratios by dividing the minimum monthly payment into the remaining balance.

You will normally end up with something that is about .005 to about .20 or so.

Whichever debt resulted in the highest number would be the debt to apply your money toward.

The Bang For Your Buck strategy is all about cash flow!

By paying off the debt with the highest ratio you will free up more cash flow to then apply towards the next debt.  But it also provides you with some flexibility too.  Maybe you don’t want to pay off all your debts for some reason.  For example, when buying a home you need a balance between cash on hand and low monthly payments.  This strategy provides you with the ability that helps you do just that.

The Numbers

I’m a numbers guy.  Do you know why?  Because I am left-brained more than I am right-brained.  I like logic.  So, the best way to compare these options is to show you what the numbers look like.

The Debts

Let’s create an example of debts to run our numbers.

  • Credit Card A ($200 balance, 13% rate and $20/mo payment)
  • Credit Card B ($1,430 balance, $11% rate and $22/mo payment)
  • Credit Card C ($425 balance, 12% rate and $30/mo payment)
  • Credit Card D ($563 balance, 13.5% rate and $35/mo payment)
  • Auto Loan A ($8,494 balance, 9% rate and $210/mo payment)
  • Auto Loan B ($5,629 balance, 10% rate and $208/mo payment)
  • Student Loan A ($4,852 balance, 4% rate and $44/mo payment)

Let’s assume we will apply $50 extra each month to pay off these debts.

Debt Reduction Strategies Compared

DEBT REDUCTION STRATEGY TIME TO PAY OFF TOTAL INTEREST PAID
Debt Snowball 40 Months $3,040.96
Debt Avalanche 40 Months $2,901.21
Bang for Your Buck 40 Months $2,932.26

The Results

Things turned out pretty much as expected.

Debt Avalanche was best in terms of interest paid.
Followed by the Bang For Your Buck.
And Debt Snowball coming in last.

One thing you may not have expected, however, is how close the total interest was between the Debt Avalanche and the Bang for Your Buck.  Just $31.05.  And the fact that they all paid off at the same time, yet the Debt Snowball still resulted in higher interest.

Why I Like the Bang For Your Buck

[click_to_tweet tweet=”Cash is king.  Having cash gives you freedom and flexibility.” quote=”Cash is king.  Having cash gives you freedom and flexibility.” theme=”style3″]

The Bang For Your Buck Strategy gives you more cash flow.  Lets compare the Avalanche and Bang For Your Buck from a cash flow perspective assuming we started our debt reduction plan in January.

DEBT PAID OFF AVALANCHE BANG FOR YOUR BUCK
Yr 1: Apr $50  $70 (paid off CC A)
Yr 1: Aug $85 (paid off CC D) $100 (paid off CC C)
Yr 1: Sep $105 (paid off CC A) $100
Yr 1: Nov $115 (paid off CC C) $135 (paid off CC D)
Yr 2: Aug $137 (paid off CC B) $135
Yr 2: Nov $137 $343 (paid off Auto A)
Yr 3: Mar $345 (paid off Auto A) $343
Yr 3: Sep $345 $553 (paid off Auto B)
Yr 3: Nov $555 (paid off Auto B) $575 (paid off CC B)
Yr 4: May $619 (paid off SL) $619 (paid off SL)

What this shows is that within 4 months we have an extra $20 in cash flow using the Bang For Your Buck compared to Avalanche.

Now the Avalanche does have a greater cash flow in September but just $5 more and only for 2 months where the bang For Your Buck takes the lead again by a $20 margin.

The biggest difference occurs in November of year 2 where the cash flow ends up $206 higher with the Bang For Your Buck strategy.  This happens again in September of year 3.

In the end the Avalanche scenario results in $31 less interest but there are a few months where you have a lot more cash flow with the Bang For Your Buck scenario giving you freedom and flexibility over the Avalanche option.

Use Your Whole Brain

The Bang for Your Buck debt reduction strategy uses your whole brain – both the logic and the emotion.

The Debt Snowball strategy works great for those that want to see results quickly.  By paying off the lowest balance first you see results which builds momentum.  The Bang for Your Buck strategy taps into this idea too by focusing on the debt that will free up the most cash flow possible.

The Debt Avalanche strategy works the best mathematically by paying off the highest interest rate debt first so you end up paying the least amount of interest possible.  The Bang for Your Buck strategy doesn’t result in the lowest amount of interest but instead gives you more flexibility while still minimizing the interest you pay.

Photo credit: Tonya Little on Flickr

Having your cake and eating it too is always the best solution, right?  Well, the Bang for Your Buck strategy does just that!

Which Option Will You Choose?

Now that you see the options and we have run the numbers which one do you think you will use for your debt reduction strategy?

Let me know your answer in the comments below…

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