The Debt Snowball
The debt snowball is the most popular debt repayment method. Under the debt snowball repayment method, you order your debts by balance with the smallest debt paid off first.
You pay down the lowest balance first with lump-sum payments, while paying the minimum on your other balances. Once the first debt is paid off, you tackle the second lowest debt by making lump sum payments towards it and minimums on the rest.
For example, you have three credit cards with three monthly payments: $25, $50 and $75. You pay off the lowest balance first with the $25 monthly payment plus any extra you can afford.
When that credit card is paid off, you take your $25 payment and apply that to the next balance accelerating the debt payoff.
With the second credit card paid off, you take the $75 from the first two debts and pay down the third one giving you $150 a month to put towards your third credit card.
The downside of the debt snowball is that you pay more in interest overall. Your lowest balance card is not necessarily your lowest interest rate.
While you focus on your lower balances, cards with higher interest rates are still accumulating higher interest charges.
So, why do the debt snowball if costs more in the long run? It's a psychological trick. By paying off lower debts, you get immediate satisfaction of paying down your debts making it more likely you stick to the program.
If it takes forever to pay off your bills, you are more likely to fall back into a debt cycle of charging and paying minimum payments.
The Debt Avalanche
If you aren't lacking in motivation, consider the debt avalanche instead. Just like the debt snowball, you order your debts from the highest interest rate to the lowest, paying them off one-by-one.
You take the monthly payments for your paid off debts and apply them to the next one rapidly paying them down.
So, what's the difference? In a debt avalanche, you order your debts by high-interest rate. You tackle the bills charging you the most interest each month and save money in the long run.
So, which method is right for you?
In most cases, the debt avalanche is the better option as you save money in high-interest rate fees. However, If your highest rate interest creditor is also your biggest bill, it'll take a long time to pay off that first debt making it more likely you give up on the debt repayment plan. If you need motivation to keep going, choose the debt snowball method instead.