With Australian household debt levels the highest they have ever been, it’s no wonder that there is a large amount of people now trying to work out what the best way to get out of debt is. Well, I have good news and bad news for you. The good news is you’re here – kudos! The bad news is that you probably have some work ahead of you to get that balance sheet into the green. But don’t worry, because the techniques we’ll be sharing will make your journey to debt freedom faster, simpler and hopefully less costly!
There are two popular methods for paying off debt, and these are known as the Debt Avalanche and Debt Snowball method. They may sound a little silly, but their purpose is to give you the path that best suits your personality to keep you motivated.
Where Should I Start?
First, list out all your debts, with their respective interest rates & minimum repayments so you have a clear view of what you’re dealing with. This step would be the same no matter which method you choose.
How Does the Debt Avalanche work?
The debt avalanche method is the one that will save you the most money on interest costs while repaying your debts. If you’re the kind of person who is very logical or practical, you’ll no doubt prefer this method.
Start by making sure you set aside the money to make the minimum repayments on all of your debts. Far worse penalties can apply by not paying at all, so you need to maintain at least the minimum payments. Now with as much additional money as you can, use that to make extra repayments on the debt incurring the highest interest rate. You would do this regardless of what the outstanding balances are, because ultimately it will save you the most money in interest.
As you can see, there isn’t a lot to it. You just need to get in that habit and keep it up. Once the highest interest rate debt is paid off, move on to the next highest and repeat.
The downside for some people is they may find it hard to stay on this path if the debt they are paying is quite large, and they don’t feel like they are making progress with multiple payments still going out everywhere. Even though this method is best mathematically, humans are emotional creatures and sometimes, the motivation can be more important. For those people, we have the Debt Snowball method.
How Does the Debt Snowball work?
The debt snowball method, as I mentioned is not as mathematically advantageous as the debt avalanche, but it focuses more on the psychological aspects of paying, and conquering your debts. This method has been praised by the likes of personal finance figure Dave Ramsey who stated that “What I have learned is that personal finance is 20% head knowledge and 80% behaviour. You need some quick wins in order to stay pumped enough to get out of debt completely.”
To follow this method, you would simply make all your minimum repayments as you would for either method. But then with as much additional money as you can, use this to pay off the debt with the lowest outstanding balance first. The purpose of this is to make the debt repayment process feel faster by allowing you to (ideally) close off some debts completely, faster. Even though you may be paying more in interest, the confidence boost in completing paying something off and not having to think about it anymore can keep you motivated so you don’t stray from your journey.
So Which Method Should I Choose?
As I mentioned, the debt avalanche method is great for people who are logical and practical, and see the long-term benefit mathematically by paying off the debt with the highest interest rate. If however you think you’d lose motivation without seeing some more visible results – such as being able to close out some debts completely sooner – then you may prefer to use the debt snowball method to give you the extra motivation to stay on track.
Regardless of which method you choose, by taking the action to prioritise paying off your debts means you’re well ahead of the average person and shows great maturity on your part. So, pick the method best suited to you and stick to it – Either way, you’ll be thanking yourself in the long-run had you not have done either of them!
DISCLAIMER: This is purely opinion and is not financial advice. You, and only you are responsible for the financial decisions you make.