Snowballs and avalanches

Picture this: you’ve got three credit cards and they are maxed out. Put aside the panic; we’re going to fix this.

Card A has $500 on it; card B has $1,000 on it; and card C has $2,000 on it. You pay your monthly minimums, no problem, and after a bit of careful budgeting, you find you’ve got an extra bit of money to put towards paying off your debts.

If the monthly minimum is $20 on each card (we wish) and you have an extra $30 to throw at your debts, what’s the best solution? Is it splitting the extra three ways and putting $30 on each card or is it concentrating your efforts on one debt at a time?

According to a study by the Harvard Business Review, ‘people are more motivated to get out of debt not only by concentrating on one account but also by beginning with the smallest.’ Debtors tend to measure success at paying off debts by their perception of how much they’re paying per debt: if you put all your efforts on paying off the smallest debt first, you get that sense of accomplishment to begin tackling the bigger debts. Small successes make for big motivation.

So, you start by focusing on card A. You pay your minimums on each card ($20) and then put another $30 onto card A. In ten months, card A is paid off. Hooray! Here’s where things get interesting. You’ve already proved you can handle paying $90 a month towards your debts, so you keep doing that. In other words, you start to snowball your debt payments.

Now that you have two cards left to pay off, you continue paying the monthly minimum on both, but you add $50 to your payments for card B. At this point, you owe $800 on card B and $1800 on card C but now you’re paying $70 towards card B every month. A year later, and card B is fully paid off. Yay! It’s time to snowball again.

Now, you’ve just got card C left with $1500 to pay (in the eleventh month of snowballing card B, you only have $10 left to clear, so we’ll assume you put the extra $60 towards card C). You keep paying the monthly minimum and you add the $70 from card B—you’ll never be paying more than $90 a month total towards your debts (unless you can!)

Before you know it, you’ve cleared card C and your total debt: at $90 a month (and no interest just for ease), you’ll wipe out $3500 of credit card debt in 39 months. The snowball method works so much better than paying off all your cards at the same time because it gives you the sense of accomplishment and momentum while also freeing up your credit faster. It takes just ten months to clear card A this way, compared to the 17 months it would take if you split the extra $30 between all three. The sooner you pay off card A, the sooner you can tackle card B and then card C. Magic.

Of course, not all of us can have interest free credit cards (but definitely look up money transfer and credit transfer cards if you’re being crippled by interest rates) so the avalanche method would make more sense. Rather than starting with the card with the smallest balance, the avalanche method begins with the card with the highest interest rate.

This won’t give you the sense of victory you’d get if you cleared the smallest debt first, but it’ll save you the most money in the long run. The aim of this game is to prevent any interest accruing as much as possible.

No matter which method you choose, the most important thing is to focus your efforts on one debt at a time. Simplify things and build the momentum to eliminate your debts one by one. ■