By iA Private Wealth, January 10, 2021
It might sound like an issue specifically for winter, but deciding whether to follow the “avalanche” or “snowball” approach to tackling debt is relevant at any time of year.
If you’ve accumulated debt – something that’s more likely once the bills arrive after the holidays – trying to reduce it can seem intimidating. Where do you start? How do you limit the amount of interest you have to pay?
The avalanche and snowball approaches are proven ways to pay off consumer debt. Before we consider how each strategy works and which one may better suit your circumstances, let’s see what these strategies have in common.
For each method, make a list of all your consumer-related debts and commit to making the minimum payment, except for one. The debt balance that you’ve singled out is what you’ll target to eliminate first. Once that balance is cleared, proceed to the next balance on your list, and so on.
Debt avalanche: Start by making a big impact
Organize your list of debts by the interest rate that’s being charged, from highest to lowest. The primary objective of the debt avalanche method is to minimize the overall interest you pay. After making the minimum payments on all debt balances except the one with the highest interest rate, put as much money as possible toward reducing the balance on this highest-rate debt (while ensuring you still have enough to live on and can maintain an emergency fund for unexpected, urgent expenses).
As you retire that highest-rate debt, set your sights on the debt with the next highest rate, and apply the same approach of paying down as much as you can each month, until that debt is retired. As you work through your list of balances – always targeting the one with the highest rate – you’ll reduce your debt and save on interest charges.
Debt snowball: Get momentum on your side
Organize your list of debts by the balance owing, from the lowest-dollar balance to the highest. As with the debt avalanche approach, ensure you have sufficient money to live on and to sustain an emergency fund. After making the minimum payment on all balances, your first target will be the smallest balance on your list. Each month, apply discretionary cash to eventually pay off this smallest balance, and then do the same for your next-smallest debt.
The snowball approach focuses on systematically eliminating the number of balances outstanding. It may be good for people who enjoy the sense of achievement that comes from seeing fewer bills arrive in their mailbox or inbox. A series of small wins could help people stay motivated to repay their debts.
Be proactive with your debt
The avalanche and snowball methods have their merits and drawbacks, but each can put you on track to eliminate debt faster. While it’s important to stay disciplined with the strategy you choose, it’s also crucial to manage future debt obligations.
An iA Private Wealth Investment Advisor can help get your budget back on track for a successful 2022. Contact one today.This article is a general discussion of certain issues intended as general information only and should not be relied upon as tax or legal advice. Please obtain independent professional advice, in the context of your particular circumstances. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.