Avalanche or Snowball: Choosing a Payoff Order

Once you know every balance and rate, the next decision is where to send each extra dollar. The two best-known answers are the avalanche, which targets the highest interest rate first, and the snowball, which targets the smallest balance first. One saves the most money; the other gives the fastest wins. This chapter shows why the avalanche costs less, when the snowball is worth its price, and how to set up either one so it runs on its own.

The shared foundation

Both methods work the same way except for the order:

1. Pay the minimum on every debt, every month, on time. Missing a minimum costs a late fee, can trigger a penalty rate and damages your credit, which undoes more progress than any method can make.
2. Decide on a fixed total monthly budget for debt: all the minimums plus an extra amount.
3. Send the whole extra amount to one target debt.
4. When the target is paid off, keep the total budget the same and send everything that was going to it, its old minimum plus the extra, to the next target. Because the payment on the target grows each time a debt is cleared, this rolling payment is what gives both methods their names.

The last step is where many plans quietly fail. When a debt is gone, its payment tends to slip back into everyday spending. Keeping the total budget fixed until the last debt is cleared matters more than which order you choose.

The avalanche: highest rate first

The avalanche ranks debts by interest rate, highest first, and ignores balances. The logic is simple: each extra dollar on a debt saves that debt's rate in interest. A dollar sent to a card at a rate in the twenties saves roughly three times as much each year as a dollar sent to a loan at a single-digit rate.

Sending $200 a month extra to the card at 24.0% saves $2,375 in interest and clears it in 17 months instead of 56. Sending the same extra to the loan at 8.0% saves only $721, even though the loan's balance is larger. That gap is the whole case for the avalanche. When the same budget is spread over several debts, ordering by rate gives the lowest total interest, and usually the earliest debt-free date.

Two refinements help. First, look for promotional rates that are about to expire: a balance at a low introductory rate today may become the most expensive debt in a few months. Second, rank by the rate you actually pay. A debt whose interest is tax-deductible costs a little less than its stated rate, as chapter 4 explains.

The snowball: smallest balance first

The snowball ranks debts by balance, smallest first, regardless of rate. It costs more interest whenever a small balance has a lower rate than a larger one. What it offers instead is speed of visible progress: whole accounts close early, and there are fewer bills to manage each month.

On its own minimum of $40, a balance of $800 would linger for 24 months. With $200 a month extra it is gone in 4 months. That first closed account is the snowball's appeal.

Is that appeal real? The research is mixed but suggestive. A study of debt-settlement clients by Alexander Gal and Blakeley McShane found that people who closed out more of their individual accounts early were more likely to finish their whole program. Laboratory work by Keri Kettle and colleagues found that people felt more motivated when payments were concentrated on one account at a time. On the other hand, a study by Moty Amar, Dan Ariely and colleagues found that people instinctively pay off small debts first even when it clearly costs them money. The fair reading: the snowball's wins can help people who would otherwise give up, but the habit of chasing small balances is also a known and costly bias.

Choosing between them

The avalanche usually fits better when:

• the rates on your debts differ a lot, for example a card in the twenties alongside a car loan at a single-digit rate;
• your highest-rate debt is also large, so the snowball would postpone it for a long time;
• you are motivated by seeing the total interest fall.

The snowball can be worth its cost when:

• your rates are close together, so the order makes little difference to interest;
• you have one or two very small balances that could be cleared within a couple of months;
• you have started and abandoned repayment plans before, and early wins would help you stay with it.

A hybrid is common and sensible: clear one or two tiny balances first for momentum, then switch to the highest rate. The debt payoff planner runs both orders on your own debts and shows the difference in months and interest, so you can see the actual price of the snowball before choosing it.

Mistakes that stall either method

• Adding new charges. Paying extra on a card while still spending on it can leave the balance flat. Take the card out of your wallet and remove it from online stores until it is clear.
• No cash buffer. Without a small emergency fund, the next unexpected bill goes back on a card. Many plans hold a starter cushion of a few weeks of essential spending before sending extra to debt; the emergency fund calculator helps size it.
• Letting freed payments leak. When a debt is cleared, move its payment to the next target the same day.
• Ignoring cheaper rates. A lower rate through a balance transfer, a hardship program or a consolidation loan can speed up either method. Chapters 6 and 7 cover how to get one and when it is worth it.
• Missing a minimum while chasing the target. Always automate minimums first.

Finding more to put toward the target

The extra payment is what drives both methods, so it is worth looking for. Cancelling subscriptions you no longer use (the subscription cost calculator totals them), calling your phone, internet and insurance providers for a better rate, selling things you do not use, and committing part of any raise or tax refund in advance all add to it. Lump sums matter too: a refund sent to a high-rate card stops that much balance from charging interest for the rest of the payoff.