Avalanche vs. Snowball

Years ago, when I had credit card debt, I tried something I'd never done before. I made the minimum payment only on all my cards except for the one with the highest interest rate. On that one, I paid as much as I could. I tracked how much I could put towards it every month, we tracked our spending to spend as little as possible, and I got the balance paid off.

Apparently this is called the Debt Avalanche: paying off your highest interest debt first. The alternative is the Debt Snowball: pay off your lowest balance first just to get it off your plate, reward yourself, give your brain the rush of completing something - that's great. But if the interest rates are significantly different, here's why the avalanche is so much better.

First let's look at the quick math and just figure up monthly interest savings.

Let's say you have $1000. You have a 4% car loan, and a 25% credit card loan.

For this simple exercise the balances don't matter! Let's look at the interest you could save next month, depending on where you put that $1000.

$1000*.04/12 = $3.30

$1000*.25/12 = $20.83

Why is the avalanche and avalanche? Because that $1000 on the credit card doesn't JUST save you $20.83 next month. It saves you $20.83 forever! For as long as that loan goes on. For life? If you look at your year ahead, it's going to save you $250 this year. If you put the extra payment towards the car loan, it will save you $40.

I can spreadsheet this year out. Let's say our balances are $10K for the car, $20K for the credit card. This is what the Debt Snowball (pay the car off first) looks like:

	Car Loan	Car interest	Car payment	Credit Card	CC Interest	CC Payment
	4%			25%
December	$10,000	$33	$1,000	$20,000	$417	$0
January	$9,033	$30	$1,000	$20,417	$425	$0
February	$8,063	$27	$1,000	$20,842	$434	$0
March	$7,090	$24	$1,000	$21,276	$443	$0
April	$6,114	$20	$1,000	$21,719	$452	$0
May	$5,134	$17	$1,000	$22,172	$462	$0
June	$4,151	$14	$1,000	$22,634	$472	$0
July	$3,165	$11	$1,000	$23,105	$481	$0
August	$2,176	$7	$1,000	$23,587	$491	$0
September	$1,183	$4	$1,000	$24,078	$502	$0
October	$187	$1	$334	$24,580	$512	$666
November	0	$0	$0	$24,426	$509	$1,000
December	0	$0	$0	$23,935	$499	$1,000

Total interest paid: $6,284

Total remaining debt: $24,279

I realize that's sad - you paid in $12K, your total debt only went down a little over $5 - that's why interest sucks.

With the Debt Avalanche you'd pay towards the credit card first:

	Car Loan	Car interest	Car payment	Credit Card	CC Interest	CC Payment
	4%			25%
December	$10,000	$33	$0	$20,000	$417	$1,000
January	$10,033	$33	$0	$19,417	$405	$1,000
February	$10,067	$34	$0	$18,821	$392	$1,000
March	$10,100	$34	$0	$18,213	$379	$1,000
April	$10,134	$34	$0	$17,593	$367	$1,000
May	$10,168	$34	$0	$16,959	$353	$1,000
June	$10,202	$34	$0	$16,313	$340	$1,000
July	$10,236	$34	$0	$15,652	$326	$1,000
August	$10,270	$34	$0	$14,979	$312	$1,000
September	$10,304	$34	$0	$14,291	$298	$1,000
October	$10,338	$34	$0	$13,588	$283	$1,000
November	$10,373	$35	$0	$12,871	$268	$1,000
December	$10,407	$35	$0	$12,140	$253	$1,000

Total interest paid: $4,835

Total remaining debt: $23,244

It's better. Not MILES better, it would still be a great idea to pay more than $1000 on this debt, the dent made in it isn't huge. But by the end of the year you're paying about $500/mo in interest with the debt snowball method, $288 with the debt avalanche. That's a LOT more of your $1000/mo going towards your principle, and your future is going to look much brighter. 

Why does this work? Without doing ALL this math, it goes back to my first point - when you put $1000 towards the credit card, you saved $20 a month. When you did it the next month, you were saving $40 a month. Then $80. But the end of the year, you're up to $220. A MONTH. 

You do not need a lot of fancy calculators to show you that it's a good idea to pay high interest first.