The greatest difficulty in debt payment is knowing the actual sum to be set aside from your income for the payment. From knowing the sum to be set aside comes identifying the actual means the debt is to be eventually paid.
When paying debt, two techniques can be applied to offer you a hassle and debt-free paying lifestyle while attending to the basic areas of life that require spending and attention. The two distinct techniques are the debt snowball and debt avalanche. Both debt-paying strategies can be used for everyday debt payments whether it’s a credit card loan, a mortgage or even a student and personal loan.
This article offers insight into both debt payment methods while identifying the differences that apply to both.
What is Debt snowball
The debt snowball technique is a payment mechanism that entails paying off debts from the smallest unit possible up to the highest. The technique demands that debtors list their debts from the smallest to the biggest debts, then the debtor moves on to have the smaller debts cleared and further concentrates on the larger debts after all small debts have been paid off.
For example, if A budgets 50,000 Naira every month for the payment of debt and has a debt outstanding at:
200,000 Naira bank loan with a 20% monthly interest rate
100,000 Naira mobile lending app loan with a 15% monthly interest rate and
300,000 Naira car loan with a 20% monthly interest rate
From the debt snowball approach, A would be made to put all his budget into financing the mobile lending loan first. This invariably means the mobile app loan and its interest would be payable in three months.
The A moves to clear the next smallest loan, which is the bank loan of 200,000 Naira, the bank loan and interest would be cleared in ten months and then subsequently, A would then channel his concentration into clearing the 300,000 Naira loan, making A debt free in less than two years.
Pros of the debt snowball
1. Realistic: One of the major advantages of the debt snowball is that it is highly realistic to undertake. The debt snowball entails debtors paying off their smallest debts, this ordinarily shouldn’t be a problem because as the small debts are cleared, a full concentration can be placed on clearing bigger debts. In other words, it’s easier to owe one huge debt altogether than to owe a series of small debts scattered everywhere.
2. Makes debt paying fun: this is an extension of the former advantage. Debt snowball allows the debtor to pay the debt in a motivational way. Motivation is perhaps the most significant advantage of the debt snowball; the idea of having to clear six smaller debts from a ten-debt list creates an enthusiasm to continue debt payment in the future.
3. Easy to undertake: The debt snowball is one of the easiest debt payment strategies to implement. All there is to do is attend to smaller debts at a time and scale up to larger ones subsequently.
Cons of the debt snowball technique
1. Interests grow: while the debt snowball might seem encouraging, it is not as expected. While debtors seek to clear up smaller loans, the interests on the larger loans pile up making it extremely difficult for the debtor to meet up with payment at the end.
An example is seen from A above, where the mobile lending loan is cleared but the 20% car loan keeps increasing every month, this would invariably become overwhelming for the debtor a the end.
2. Takes time: Another drawback of the debt snowball technique is that it takes an extremely long time to clear up, this is mostly caused by the increased interest rates that have piled up over the years.
What is Debt Avalanche
The debt avalanche technique calls for a process that is extremely different from the debt snowball. The debt avalanche technique demands that the debtor pays a certain portion of all his debts owed and subsequently channels the remaining sum to clear the biggest debt owed.
Using the same example as in the debt snowball, if A budgets 50,000 Naira every month to the payment of debt and has a debt outstanding at:
200,000 Naira bank loan with a 20% monthly interest rate
100,000 Naira mobile lending app loan with a 15% monthly interest rate and
300,000 Naira car loan with a 20% monthly interest rate
Applying the debt avalanche A would pay 10,000 Naira on each debt and pay the remainder 20,000 Naira on the biggest debt, which is the car loan. At the end of the month, A would have paid 10,000 Naira on the bank loan, 10,000 Naira on the money lending app loan and 30,000 Naira on the car loan.
Pros of the debt avalanche
1. Excellent on a budget plan: the debt avalanche takes the win for being significantly adaptable to a budget plan. The technique lets debtors budget their way through debt payments without having to spend any extra sum.
2. Keeps credit score intact: Because the debtor is still financing his debts, the credit score stays intact while the debts are being paid gradually.
3. Reduces the number of interest payable: The amount of interest payable on the debt is reduced because the bigger debt and all other debts are being financed by the debtor.
Cons of the debt avalanche
1. It can be a bit discouraging: Having to go through several months and still have none of your smaller or bigger debts settled can be very discouraging.
2. Requires discipline: Most times the debt avalanche requires a great deal of discipline to pull off. The fact that the progress is a bit slow and only takes patience to pull through success can be overwhelming.
Conclusion
The debt avalanche and the debt snowball both demand that the debtor list down his debts in the manner from smallest to the biggest debts payable. The debt payment technique you choose to apply will eventually cut across these two debt payment strategies. Both are good and none is significantly better than the other. The key to succeeding with any of them is commitment.
This article provides the differences between the debt snowball and the debt avalanche method of debt payment.
