If you are currently enmeshed in a debt trap, you might want to adopt strategies for debt reduction. It is a common occurrence for individuals to avail a short term personal loan during contingency situations. Loans for people with bad credit come with exorbitant interest rates, which add to the difficulty of quick loan repayment. Some of the popular debt reduction strategies include debt snowballing and avalanche (stacking). However, which is better? Let us have a look at these strategies to help you make a more informed decision regarding your finances.
Snowballing entails listing all outstanding debts in ascending order and paying off the smallest balance while only paying the minimums on the others. For instance, if an individual has a student loan of Rs. 30,000 at 4% interest, a credit card balance of Rs. 40,000 at 11% interest, and a car loan of Rs. 1,00,000 at 9% interest, they need to pay off the student loan first, followed by the other outstanding loan amounts. Once the smallest debt is paid, you can move on to the next thing, using the same strategy until all debts are paid.
Snowballing – Pros and Cons
The prospect of mental satisfaction that comes along with striking a debt off your list is immense. Snowballing can also motivate the borrower to pay off their remaining debts as quickly as possible. Managing finances becomes easier, and the borrower is most likely to become debt-free in a matter of months.
On the other hand, snowballing can cost you more money, as it is difficult to tackle interest rates that do not work in your favour. This method also demands a certain amount of discipline and a focused mindset.
In order to use the Avalanche method, one needs to list their debts in descending order, in terms of interest rate instead of the loan amount. The loans with the highest interest rates are paid off first, and you work your way downwards, like an avalanche. One needs to continue doing so until all debt amounts are paid off.
Avalanche – Pros and Cons
Most financial advisers opine that the stacking method is most financially viable. The avalanche method warrants paying less in terms of interest rates. Generally, borrowers pay around 34% of their lifetime income as interest – if one is able to minimize this statistic, it is a sign of financial health and maturity.
In terms of cons, the avalanche method is a time-consuming process, which in turn, can discourage the borrower. There is no sense of gratification involved as the repayment process is slow and cumbersome.
Snowballing VS Avalanche – Which is Better?
If we were to compare the two methods to ascertain which one is better, one would come to realize that the snowballing method costs twice as much in terms of interest rates. While the avalanche method is more time-consuming in comparison to the snowballing method, the former is more profitable and sustainable in the long run.
Now that you are aware of the nuances of these methods, you can decide which debt reduction strategy to adopt as per personal preferences. If confusion persists, you can consult a financial advisor for the same.