Today’s reader question comes from Matthew. Matthew wants to know how to pay off his debts quickly and efficiently. but he’s not sure which one to start with. Matthew has three debts:
- Student loan of $20,842 at 5.20%. His minimum payment is $208 per month and 11.8 years remaining.
- Car loan of $14,600 at 2.99%. His car payment is $192.85 for another seven years.
- A mortgage of $257,000 at 2.94%. His mortgage payment is $1,210 and is amortized over 25 years.
Matthew wants to know which debt to pay off first, and how long until he’s debt free entirely. He has an extra $600 per month to throw at his debts.
Snowball or Avalanche Method
There are two primary tactics for debt repayment in the personal finance world. The first method is the snowball method. This method was popularized by Dave Ramsey and recommends attacking the loan with the lowest balance first. Once that loan is paid off, you snowball that loan payment towards your other payments.
The idea behind the snowball method is that humans like quick wins, and paying off smaller balances rapidly builds up your debt repaying confidence and gives you the enthusiasm you need to tackle your bigger loans. Basically, it factors in the human element of money management. Here’s how Matthew’s debts would be paid off using the snowball method.
Snowball Debt Payoff
Using the snowball method, Matthew would attack his smallest debt first. That would be his car loan. If he added his $600 per month extra payment to his car loan, he’d have it paid off by June 2017.
So in July 2017, he’d own his car free and clear, and he’d be free to roll his $192.85 car payment plus the $600 per month extra payment towards his next loan, the student loan.
By July 2017, he’ll have $18,414.41 left owing on his student loans and it’ll take 9 years and three months if he only makes minimum payments. But now he’s got that $600 per month to pay towards his student loans, plus the $192 ex-car payment money. If he puts that $792 towards his student loans every month, along with his $208 minimum payment, he’ll have that sucker paid off by February 2019.
Using the snowball method, Matthew would be non-mortgage debt free by February 2019. Not bad for $35,000 of debt!
(Edit: I originally referred to this as the “snowflake” method but the lovely Cat informed me that most people call this the debt avalanche, so I changed it.)
The snowball method is a popular way to tackle debt, but there is another way. Another method is to tackle the debt with the highest interest rate first. This is what I did with my debt.
If Matthew uses the avalanche method, he would start paying off his student loans first. His student loans are costing him more dollars per day than his car loan because both the balance and interest rate are higher.
If Matthew paid an extra $600 towards his student loans every month, he’d have the balance paid off by March 2018. At that point, Matthew’s car loan will have a balance of $10,208 and four years and ten months remaining on his loan if he only makes minimum payments. But he’s not going to make minimum payments, he’s going to roll his $600 monthly extra payment and the $208 from his now-slain student loan payment towards his car loan for a total monthly payment of $600 + 208 + 192 = $1,000.
If he does this, he’ll be debt free by January 2019, a full month earlier than with the snowball method.
We could also look at this in terms of how much interest is paid over the life of the loans using each method. Here approximately how much interest Matthew would pay using the two methods (this number would vary depending on if he made monthly, weekly or biweekly payments.)
Which Debt to Pay Off First?
Only Matthew can decide which method he would prefer to use. Using the avalanche method, he would pay his debt off a full month earlier and pay about $600 less in interest, but he would have to tackle his biggest loan first. It may be easier, psychologically to tackle his much smaller car loan first. Personally, I would, and have, chosen the avalanche method.
If Matthew wanted to pay off his debt even faster, he could use the methods I outline in this blog post.
Life After Debt
By paying off his student loan and car loan, Matthew has freed up $600 + $192 + $208 = $1,000 in his budget. I don’t now anything about Matthew’s finances other than his debt load, so I’m about to make some assumptions:
I should have mentioned this at the beginning of the post (thanks for reminding me, Bridget) but Matthew should have a small emergency fund of at least $2,000 set up before he starts paying down his debt seriously. After his debt is paid off, he should divert some of this newly freed up cash towards setting up an emergency fund of three to six months of living expenses. Again, I don’t know Matthew’s sitaution, he could already have a fully funded emergency fund.
If he isn’t already, he should also start contributing to his retirement.
He could start making extra payments on his mortgage too if total debt freedom is a priority. Let’s say Matthew kept $800 of that extra money for retirement and other savings and put $200 per month towards his mortgage payment. Matthew would pay off his mortgage five years early.
To find out if the snowball or avalanche method is right for your debt repayment journey, download my debt repayment spreadsheet and map out your debts.