If you’re staring at a mountain of debt, you’re not alone. Northwestern Mutual’s Planning and Progress Study found that in 2020, the average American with debt pays 33 percent of their monthly income toward it. How can you get out from under that much debt? A couple common paydown strategies can help.
Here’s what you should know about two popular repayment strategies — debt snowball and debt avalanche — to help you decide if one is right for you.
If you like celebrating wins or if checking something off your list motivates you, debt snowball may be the strategy for you. The debt snowball strategy has you start by paying the debt with the smallest balance first, while also making the minimum payments on all your other debts. Each time you pay off a debt, you move to the debt with the next smallest balance and so on.
Pros: The debt snowball strategy can be appealing due to its quick-win nature. For some people, seeing their list of debts decrease in a short amount of time can give them the motivational boost they need to stay on track.
Cons: The biggest drawback of the debt snowball strategy is that you could end up paying more interest over time, which of course extends the length of your debt repayment process.
If seeing the overall balance that you owe decrease as quickly as possible, debt avalanche is for you. With debt avalanche strategy, you start by paying the debt with the highest interest rate first, while also making the minimum payments on all your other debts. Once you pay off the balance with the highest interest rate, you move to the balance with the next highest interest rate and so on.
Pros: This strategy is often preferable because it saves you more money in the long run — paying the debt with the highest interest rate first means paying less interest overall.
Cons: The flip side of tackling the debt with the highest interest rate first is that it’s likely to be the debt with the highest balance. For some people, it can feel discouraging when it appears that little progress being made.
OTHER TIPS FOR PAYING DOWN DEBT
When you decide to start tackling debt, the most important thing you can do is to make a plan that is manageable and easy to stick to. Start by creating a budget that’s both feasible and realistic and covers your non-negotiable expenses. From there, any leftover money can be considered for accelerating your debt payments. Because while it’s tempting to pay off your debt as soon as possible, it’s also important that you balance it with other goals like building up your emergency fund or saving for retirement.
Jennifer Raess, CFP®, a member of the Advice Practice Team at Northwestern Mutual shares some additional tips and considerations to keep in mind when tackling your debt:
Make sure to always make the minimum payments on all your debts.
When deciding which debts to accelerate paying off, keep in mind that not all debt is considered “bad.” Some debt, like mortgages and student loans, are often considered “good” debt, whereas credit card debt is typically considered “bad” due to high interest rates.
When it comes to interest rates, consider whether your debt has a fixed or variable rate. Debts with variable rates should be paid off first to mitigate the risk of a rate increase.
In the end, the best strategy will depend on your financial situation, and a financial advisor can help you figure out which debt repayment strategy is right for you.