Effective strategies for debt repayment: Avalanche and snowball methods to manage financial stress

Owing multiple loans and paying them off becomes a stressful task sometimes but the right planning always helps to manage the mental and financial pressure, planning to reduce them can be a huge relief. Money and time are the two important factors of human life and should be used wisely while living life.

There are two basic strategies used for paying off the debt called avalanche method and the snowball method. The goal is to pay off all the debt but the approach used is different and provides relief for the borrower in different situations as per the requirement and the method used. The avalanche method begins with the highest interest rate while the snowball method starts with the lowest balance.

By using the avalanche method you may save more on interest but using the snowball method can be emotionally satisfying as you clear away smaller, lingering debts first.

Debt Avalanche Method

The debt avalanche method allows you to save more on interest payments if you have multiple loans with a wide range of interest rates. This method will reduce your loan faster because the approach tackles the loans with the biggest interest rates first.

As you pay off one debt, you put all the money you were using for it into paying off the next one. By the time you reach the last debt, you will be able to put a lot more money towards it, speeding up the process. It is called an "avalanche" because the payments get bigger as you go, making it faster to clear the final debt.

You can simply follow the simple steps given below for implementing the avalanche method:

• Arrange all loans by their interest rate, from highest to lowest.
• Calculate the minimum payment.
• Devote any extra money to paying down the debt with the highest interest rate.
• After you pay off that debt, direct the money you had been putting toward it to the debt with the next-highest rate.
• Continue until you have paid off all of your debts.

Debt Avalanche Example,

You have ₹8,000 extra to devote to debt repayment each month, and you have the following loans:

₹65,000 credit card debt at a 3% monthly interest rate ₹6,00,000 personal loan at 11.00% interest rate (annual) ₹4,00,000 student loan at 9% interest rate (annual)

Minimum Payments on Loans: You should continue making the minimum payments on all your loans while putting any extra money toward the loan with the highest interest rate.

Assume the following minimum payments:

• Credit card debt: ₹1,950 (3% of ₹65,000)
• Personal loan: ₹13,000 (approximately 2.17% of ₹6,00,000 based on EMI calculations)
• Student loan: ₹8,000 (approximately 2% of ₹4,00,000 based on EMI calculations)

Extra ₹8,000 Allocation: After making the minimum payments, you will put any remaining money toward the loan with the highest interest rate (credit card in this case).

Plan overview:

Step-by-Step Plan:

First Target: Credit Card Debt (36% interest rate)

• Total Payment: ₹1,950 (minimum) + ₹8,000 (extra) = ₹9,950 per month
• The credit card debt will be paid off in 7 months (₹65,000 / ₹9,950 ≈ 7).

Second Target: Personal Loan (11% interest rate)

• Once the credit card is paid off, allocate the ₹9,950 to the personal loan.
• Now you will pay ₹13,000 (minimum) + ₹9,950 (extra) = ₹22,950 per month.
• This loan will be paid off in around 26 months (33 months total).

Third Target: Student Loan (9% interest rate)

• After clearing the personal loan, focus on the student loan.
• Allocate ₹8,000 (minimum) + ₹22,950 (extra) = ₹30,950 per month.
• This loan will be paid off in about 13 months (46 months total).

If you have significant amounts of debt, the avalanche method of targeting the highest interest-rate debt can also reduce the time it takes to pay off the debt by a few months.

Debt Snowball Method

This method asks you to attack smaller balances first, with this strategy you start by listing your debts by balance size, with the smallest at the top and the largest at the bottom. As you pay off smaller debts, the amount of money you can put toward larger balances grows like a snowball rolling down a hill.

For Example, You have ₹20,000 extra to devote to debt repayment each month, and you have the following loans:

₹2,00,000 credit card debt at a 3% monthly interest rate ₹5,00,000 student loan at 10% interest rate (annual) ₹3,00,000 personal loan at 13.00% interest rate (annual)

Debt repayment plan overview:

• Total Payment: ₹6,000 (minimum) + ₹20,000 (extra) = ₹26,000 per month.
• The credit card debt will be paid off in about 8 months (₹2,00,000 / ₹26,000 ≈ 7.69).

• Once the credit card is paid off, allocate the ₹26,000 to the personal loan.
• Now you will pay ₹6,000 (minimum) + ₹26,000 (extra) = ₹32,000 per month.
• This loan will be paid off in around 9 months (₹3,00,000 / ₹32,000 ≈ 9.38).

By using the snowball method Credit Card Debt will be cleared in 8 months. Personal Loan will be cleared in an additional 9 months (17 months total). The student loan will be cleared in an additional 14 months (31 months total).

By following the debt snowball method, you will start with the smallest debt, gaining momentum and motivation as you clear each debt one by one.

Which method to use?