When it comes to paying off debt, you may have heard 1,000 pieces of advice — stop investing while you pay it off; start with the smallest balance; no, start with the highest interest rate; consolidate your debt; don’t consolidate your debt.
Sorting through the advice can be tough. And, admittedly, this is all personal. Sometimes you should slow down or stop investing to get rid of high-interest debt. And sometimes you should consolidate, or not consolidate. It really depends on your personal situation.
But with one debt payoff argument, academic researchers have stepped in to help.
Which argument, you ask? The debt snowball vs. debt avalanche argument. First, let’s talk about the difference. Then, we’ll see how social scientists think you should pay off your debt.
The debt snowball method
The debt snowball method was popularized by Dave Ramsey, but lots of people talk about it now. Here are the debt snowball steps:
- First, pay the minimum monthly payment on all of your debts.
- Then, devote any leftover money to the debt with the smallest balance.
- Once that debt is paid off, devote its previous monthly payment and leftover money to your next-smallest debt.
The theory here is that you get a small win up front. Often, you can pay off your smallest debt in just a couple of months. Also, by the time you start focusing on the debt with the largest balance, you’ll be throwing huge amounts of money at it monthly. This can make that looming student loan or mortgage balance seem less intimidating.
Of course, paying no heed to interest rates can cost you money as you pay off debt. We’ll talk more about that in a moment, but that’s the major flaw in this method.
The debt avalanche method
The debt avalanche method is very similar to the debt snowball approach. You make minimum payments on all your debts. As you pay off each debt, its minimum payment gets added to the monthly payment for the next debt. Again, by the time you get to your last debt, you’re taking huge chunks out of it each month.
The difference with the debt avalanche is that you order debts not by their balance, but by their interest rate. You start by paying off the highest interest rate debt first. Then, you work your way through to the lowest interest rate debt on your list.
As you might guess, the math normally works better with the debt avalanche.
How the math shakes out
Let’s say we have the following balances, minimum payments and interest rates:
- Credit card A: $3,500, 17.99 percent APR, $90 monthly payment
- Credit card B: $7,500, 18.00 percent APR, $150 monthly payment
- Student loan A: $10,000, 7.5 percent APR, $70 monthly payment
- Student loan B: $7,000, 8.5 percent APR, $55 monthly payment
- Car loan: $4,500, 6.5 percent APR, $200 monthly payment
- Personal loan: $1,000, 10 percent APR, $30 monthly payment
Let’s say you’re budgeting $800 per month to pay off debt. That’s your minimum payments of $505 plus an extra $295.
With the debt snowball, you’d start with the personal loan and move on up balance-wise. You’d pay off the larger student loan last. With the debt avalanche, you’d start with the higher-interest credit card and end with the car loan.
So what’s the difference, mathematically?
With the snowball method, you’d pay off your debts in 52 months and pay a total of $8,007 in interest. With the debt avalanche, you’d also pay off your debts in 52 months, but you’d pay a total of $7,784 in interest. That’s a savings of $223.
So it seems like you should go with the debt avalanche, right? After all, a penny saved is a penny earned. But hang on. Let’s see what the science says.
What social science says
In short, the science says that humans aren’t really rational creatures. The rational thing to do would be to choose the debt payoff method that saves the most money in interest. But that’s not the best way to pay off debt, according to several studies. Here’s a quick summary:
Kellogg School of Management: This 2012 study showed that people with large balances are more likely to stick with their debt payoff plan if they focus on smaller balances first.
David Gal, one of the professors who ran the study, said, ‘We found that closing debt accounts — independent of the dollar balances of the closed accounts — predicted successful debt elimination at any point in the debt settlement program.”
In short, it’s better to pay off lower balances quickly so that you’ll stay motivated for the long term.
University of Michigan: This study from 2011 played out four experiments which showed, in short, that participants tended to naturally follow the debt snowball method. However, when participants weren’t allowed to pay off the full account balance on smaller debts and were shown how much interest accrued on each debt, they were able to focus on higher-interest debts first.
Boston School of Business: This more recent study actually tested three different debt pay-down strategies. First, the experimenters looked at an anonymous data set. It showed that people who focus on paying down one account at a time are more successful than those who spread extra payments across accounts.
Then, the professors did experiments with real people and imaginary debt. They ran three experiments that found:
- Participants who focused on one account at a time worked harder to pay down their debt.
- Paying down debt one account at a time helped participants feel their progress more keenly and remain more motivated.
- Participants focused most on what portion of the account balance they succeeded in paying off.
In short, the research agrees with the first study that paying debts off one at a time, starting with the smallest account balance, is the way to go.
What’s best for you?
The research — and plenty of on-the-ground experience from financial experts — shows that it’s much easier to stay motivated when you pay off smaller debts first. In our mathematical example, using the debt snowball would cost you money. But it would also mean you’d pay off your first debt within five months. Compare that to 26 months under the debt snowball, and you can see why that method might get taxing.
But the bottom line is still that personal finance is just that — personal.
If you’re wondering which debt payoff method to choose, here’s some general advice:
- Do the math first. Sometimes laying out the math — and reminding yourself of it — can help you keep making the rational choice, even when it’s not the most motivating option.
- Dig into the numbers. In the above example, there’s not a huge difference in total interest paid between the two methods. There’s not even a difference in how long it’ll take to pay off your debt. In your situation, the difference will depend on your account balances and the difference in interest rates.
- Make the rational choice, if you can. If a debt avalanche approach will save you $1,000s, try starting off with that method. It could be well worth the extra mental effort!
- Keep tabs on your motivation level. If you notice your motivation start to flag, consider knocking out a couple of smaller balance debts just to get a quick energy boost. In this way, you might wind up using a combination of the two approaches over time.
- Focus on one account at a time. The research is clear that paying extra on one account at a time makes a huge difference. It helps you pay off debt more quickly and stay on track with your financial plan. Regardless of how you decide to order your accounts, pay down just one at a time.
- Stick to it. Getting out of debt can be hard, even if you choose a method of small wins. Keep running the numbers, though, and you’ll see just how worthwhile your efforts will be.
Finally, keep in mind that getting out of debt involves a lot more than picking a debt payoff method. It also includes budgeting, refinancing debt to lower rates and lifestyle changes. So be sure to take a comprehensive approach to paying off your debt.