If you have extra money to put towards your loans, you might be wondering what the best course of action is. People typically choose to divide the extra amount of money between different loans, but there happens to be two ways to tackle your debt -- the snowball method and the avalanche method.
If you want to pay the least amount of interest possible, the avalanche method is right for you. You sort your loans from highest interest rate to lowest and pay them in that order. For example, if you had one $5,000 loan at 15 percent interest, one $2,500 loan at 10 percent and one $1,000 loan at 6 percent, you'd start paying the $5,000 one first, regardless of the balance.
You'll save the most money by paying off your loans with the highest interest rate.
However, the snowball method has been proven to be the best at getting people to actually stick with paying back their loans. You sort your loans from lowest to highest, and then you start paying off the loans with the lowest balance.
The way this works is that you should ignore the interest rates on your loans, and instead focus on knocking out one loan at a time. When you make a payment toward the smallest loan, you can pay it off faster than you would if you focused on the loan with the highest interest rate.
So why is the snowball method so effective at getting people to pay off their loans even though it doesn't make financial sense? Because paying off your loans is difficult and it can be hard to feel motivated when you're in debt for thousands of dollars -- which can seem never ending.
For many of us, we count our debt by how much we owe and how many accounts we have. Even if you're paying extra on your loans, your total amount will not decrease very quickly. What the snowball method does is ease the mind to feel like it is seeing progress -- if you knocked out one loan out of five at a time you feel a sense of accomplishment. After you pay off your smaller loans, you can put extra money toward the next loan.
For example, if you have three loans, one at $500, one at $1,000 and one at $2,000, you would start by paying the $500 loan. Even if you don't have any extra money to put toward the loans besides the minimum payments, you can take how much you were paying on the $500 loan and once you're done paying it off, put it toward the $1,000 loan. Once you're done with that one, you put it toward the $2,000 loan. It creates a snowball.
The snowball method is especially beneficial for people who might have a variety of loans and feel overwhelmed when it comes repayment. If you feel disciplined enough to pay off your loans, you can should use the avalanche method to save the most on interest payments. By paying off a loan early, you can save thousands in interest.
The good news is that these two methods can apply to any loans you might have, including student loans, car loans and mortgages. The only decision you have to make is how much money you can pay on top of your minimum payments and what kind of method you'd like to use.
Are you a disciplined and patient person who values saving as much money as possible? Then the avalanche method could be right for you. It requires someone who is content with waiting longer to knock out loans for the simple reward of paying less interest.
Are you an eager person motivated by results rather than wait time? Then the snowball method is for you. This method of paying off debt is great for people who need small victories to keep going along their path. It provides rewards and incentives to people who might feel overwhelmed and tired of paying off debt.
Sites like unbury.me have calculators that allow you to test out the various methods to see which one is right for you.
Whichever method you go with -- remember that neither one is wrong. The avalanche method saves you more money, but the snowball method is proven to be helpful in assisting people pay off their debt. My advice is to consider the amounts and interest rates of your loans, as well as consider the kind of personality you have. You'll know which loan to pay off first.
Aryea Aranoff works on strategy, marketing and technology at DRB Student Loan, a marketplace lender and FDIC-insured bank offering low rate student loan refinancing to working professionals and parents with PLUS loans. DRB Student Loan is a leader in this space offering some of the lowest rates in the country on its student loans.
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