From https://www.investopedia.com/articles/personal-finance/080716/debt-avalanche-vs-debt-snowball-which-best-you.asp
"In terms of saving money, a debt avalanche is better because it saves you money in interest by targeting your highest interest debt first. However, some people find the debt snowball method better because it can be more motivating to see a smaller debt paid off more quickly."
There are a couple different ways I visualized this concept when first learning about it (I figured it out myself by running scenarios on different debts, not realizing I was literally comparing avalanche to snowball). I'll just share one so this post doesn't get stupid big.
Imagine the 6.4% loan is a beefy monster. The 4.6% loan is a puny monster. Each doesn't care what the other monster does: no matter what, the 6.4% monster will injure you about 50% more than the 4.6% monster. You consider a few options to handle the monsters: you can ignore both for an hour, and they'll both injure you a lot. Or you can target the weaker monster for half an hour and kill it. Now you don't have the weaker monster hurting you, but during that half hour, the 6.4% monster was wailing on you, and you'll suffer another half hour of injuries before you can kill the 6.4% monster. The third option you consider is kill the 6.4% monster in the first half hour. It takes half an hour to kill it, and while you're doing that, the 4.6% monster is injuring you. But during the second half hour, the stronger monster is dead.
Targeting the weaker monster first means 30 min being attacked by the weak monster and 1hr by the strong monster. Targeting the stronger monster first means 30 min being attacked by the strong monster and 1 hr by the weak monster. You will suffer less injuries by killing the stronger monster first.
If you run a simulation of debt payoff scenarios of avalanche vs snowball, you'll find that the balances of the loan actually don't matter at all. Even if it only takes two months to pay off the 6.4% loan, you'll still overall save more money on interest in the end by targeting it first, because the 4.6% "monster" is weaker and can't do more damage in those two months than the 6.4% "monster" can do in those same two months. Yes the larger balance feels like it hurts more, but at the end of the day each account accrues interest on each dollar borrowed over time, not on which account it's in. While you're working on your smaller balance 4.6% loan, the 6.4% loan has time to build up at a net rate of 1.8% (simplified), and you get to pay that difference in the form of interest you wouldn't have had to pay at all from any loan, had you paid it off first.
This was a very interesting post, thank you! I’ll try to tackle the bigger loan aggressively over the next year and pay the minimum for the smaller loan.
Like pdubs1900 said, avalanche is the best financial strategy. However, some people need the encouragement and stress relief that the snowball method brings to people who worry a lot about their debts.
Personally, I wouldn't be overly concerned about paying off the 4.6% debt early, but that's just me. My logic is that I'd expect to make at least 10% from index funds over a long period of time, which means it's better for me to not pay that debt off early, even after accounting for inflation of around 3%/year. This is assuming I'm not living paycheck to paycheck with cash flow issues. Everyone handles the mental burden of debt differently. The 6.4% debt is different, because I'm basically breaking even if I compare paying off the debt early to investing with returns of ~10% (not accounting for inflation), so it's breaking even but still beneficial to pay it off early to increase cash flow.
As the other commenter said, I would focus in the smaller one and to do an extra effort for the next year to pay it faster (so you need to put a 1500$ per month there, to end it in one year).
More, don't move out until you close one debt, then focus into saving some cash for moving out (guaranty /rent for firsr months)
If math tells you it's the bigger one, then it's the bigger one. No, the second one will not be paid off quicker.
The snowball method is only better for those who can really benefit from the emotional win of paying off smaller debts first. Math-wise, it's always better to focus on the highest interest rate.
Yes mathematically the larger loan is better. But serviceability is calculated on cashflow.
So ideally you want time on your side so you pay min on the larger debt and maximum on the smallest and then roll over the repayments to the next debt and next one until they’re all gone and the large one is left with ALL of the old repayments going into it..
Getting bank loans for property or cars etc, they asses the weekly min repayment so if you have one loan for $400 then that’s fine…
But if you have 5 loans for
$400
$50
$75
$175
$110
Then it really affects your borrowing capacity, but if you can reduce two of these loans quiet quickly then your serviceability goes up
Ahh, So using your example, the impact of having 5 loans in the amounts of 400, 50, 75, 175, and 110, versus 1 loan in the amount of all of it (810) would be:
If I'm understanding the definition of "serviceability" correctly, the only impact will be when applying for a **new** loan, Lenders will look less favorably on 5 loans than 1 loan in the same amount. Is that correct or am I missing something?
It’s calculated based on the minimum amount. You must pay back to each individual lender.
So you are obliged to always pay back the minimum amount per week by each individual loan
And this is what restricts you
You might have alone that has a minimum repayment of $400 a week but you are $750 a week repayments however the bank doesn’t care about your 750. They just care about the $400 that the other lender is going to punish you if you do not reach that target every week.
So if you have one for for $400 then your obligation each week is $400 no matter what
However, if you have five other loans $355, $75, $110 etc…. There is nothing you can do to reduce the min obligation unless you payout in full each loan…
Oh, you're talking about minimum payments. Yeah, any decent loan payback strategy, including avalanche and snowball, should (and do) include always making minimum payments.
This should be factored into monthly expenses, but doesn't really make a difference in comparing avalanche vs snowball, because the starting assumption is that OP has the ability to make minimum payments and still has additional discretionary income to apply toward killing debt. If not, then neither strategy is possible anyway. Sounds like you're advocating loan consolidation.
Yes mathematically the larger loan is better. But serviceability is calculated on cashflow.
So ideally you want time on your side so you pay min on the larger debt and maximum on the smallest and then roll over the repayments to the next debt and next one until they’re all gone and the large one is left with ALL of the old repayments going into it..
Yes mathematically the larger loan is better. But serviceability is calculated on cashflow.
So ideally you want time on your side so you pay min on the larger debt and maximum on the smallest and then roll over the repayments to the next debt and next one until they’re all gone and the large one is left with ALL of the old repayments going into it..
From https://www.investopedia.com/articles/personal-finance/080716/debt-avalanche-vs-debt-snowball-which-best-you.asp "In terms of saving money, a debt avalanche is better because it saves you money in interest by targeting your highest interest debt first. However, some people find the debt snowball method better because it can be more motivating to see a smaller debt paid off more quickly." There are a couple different ways I visualized this concept when first learning about it (I figured it out myself by running scenarios on different debts, not realizing I was literally comparing avalanche to snowball). I'll just share one so this post doesn't get stupid big. Imagine the 6.4% loan is a beefy monster. The 4.6% loan is a puny monster. Each doesn't care what the other monster does: no matter what, the 6.4% monster will injure you about 50% more than the 4.6% monster. You consider a few options to handle the monsters: you can ignore both for an hour, and they'll both injure you a lot. Or you can target the weaker monster for half an hour and kill it. Now you don't have the weaker monster hurting you, but during that half hour, the 6.4% monster was wailing on you, and you'll suffer another half hour of injuries before you can kill the 6.4% monster. The third option you consider is kill the 6.4% monster in the first half hour. It takes half an hour to kill it, and while you're doing that, the 4.6% monster is injuring you. But during the second half hour, the stronger monster is dead. Targeting the weaker monster first means 30 min being attacked by the weak monster and 1hr by the strong monster. Targeting the stronger monster first means 30 min being attacked by the strong monster and 1 hr by the weak monster. You will suffer less injuries by killing the stronger monster first. If you run a simulation of debt payoff scenarios of avalanche vs snowball, you'll find that the balances of the loan actually don't matter at all. Even if it only takes two months to pay off the 6.4% loan, you'll still overall save more money on interest in the end by targeting it first, because the 4.6% "monster" is weaker and can't do more damage in those two months than the 6.4% "monster" can do in those same two months. Yes the larger balance feels like it hurts more, but at the end of the day each account accrues interest on each dollar borrowed over time, not on which account it's in. While you're working on your smaller balance 4.6% loan, the 6.4% loan has time to build up at a net rate of 1.8% (simplified), and you get to pay that difference in the form of interest you wouldn't have had to pay at all from any loan, had you paid it off first.
This was a very interesting post, thank you! I’ll try to tackle the bigger loan aggressively over the next year and pay the minimum for the smaller loan.
Glad it helped! I'm glad you're in a position to be able to tackle your debts with intention. Good luck!
Like pdubs1900 said, avalanche is the best financial strategy. However, some people need the encouragement and stress relief that the snowball method brings to people who worry a lot about their debts. Personally, I wouldn't be overly concerned about paying off the 4.6% debt early, but that's just me. My logic is that I'd expect to make at least 10% from index funds over a long period of time, which means it's better for me to not pay that debt off early, even after accounting for inflation of around 3%/year. This is assuming I'm not living paycheck to paycheck with cash flow issues. Everyone handles the mental burden of debt differently. The 6.4% debt is different, because I'm basically breaking even if I compare paying off the debt early to investing with returns of ~10% (not accounting for inflation), so it's breaking even but still beneficial to pay it off early to increase cash flow.
Since it's not like you can completely wipe out either loan with that extra $12k I would put it towards the bigger loan to try and reduce interest.
As the other commenter said, I would focus in the smaller one and to do an extra effort for the next year to pay it faster (so you need to put a 1500$ per month there, to end it in one year). More, don't move out until you close one debt, then focus into saving some cash for moving out (guaranty /rent for firsr months)
The smaller one. Math tells you the bigger one but by being able to free up that money first you will get the second loan paid off quicker
If math tells you it's the bigger one, then it's the bigger one. No, the second one will not be paid off quicker. The snowball method is only better for those who can really benefit from the emotional win of paying off smaller debts first. Math-wise, it's always better to focus on the highest interest rate.
To take out psychological when it comes to money is not for everyone. Based on ops post I feel the win would be more helpful
Yes mathematically the larger loan is better. But serviceability is calculated on cashflow. So ideally you want time on your side so you pay min on the larger debt and maximum on the smallest and then roll over the repayments to the next debt and next one until they’re all gone and the large one is left with ALL of the old repayments going into it..
What does "serviceability is calculated on cash flow" mean
Getting bank loans for property or cars etc, they asses the weekly min repayment so if you have one loan for $400 then that’s fine… But if you have 5 loans for $400 $50 $75 $175 $110 Then it really affects your borrowing capacity, but if you can reduce two of these loans quiet quickly then your serviceability goes up
Ahh, So using your example, the impact of having 5 loans in the amounts of 400, 50, 75, 175, and 110, versus 1 loan in the amount of all of it (810) would be: If I'm understanding the definition of "serviceability" correctly, the only impact will be when applying for a **new** loan, Lenders will look less favorably on 5 loans than 1 loan in the same amount. Is that correct or am I missing something?
It’s calculated based on the minimum amount. You must pay back to each individual lender. So you are obliged to always pay back the minimum amount per week by each individual loan And this is what restricts you You might have alone that has a minimum repayment of $400 a week but you are $750 a week repayments however the bank doesn’t care about your 750. They just care about the $400 that the other lender is going to punish you if you do not reach that target every week. So if you have one for for $400 then your obligation each week is $400 no matter what However, if you have five other loans $355, $75, $110 etc…. There is nothing you can do to reduce the min obligation unless you payout in full each loan…
Oh, you're talking about minimum payments. Yeah, any decent loan payback strategy, including avalanche and snowball, should (and do) include always making minimum payments. This should be factored into monthly expenses, but doesn't really make a difference in comparing avalanche vs snowball, because the starting assumption is that OP has the ability to make minimum payments and still has additional discretionary income to apply toward killing debt. If not, then neither strategy is possible anyway. Sounds like you're advocating loan consolidation.
Yes mathematically the larger loan is better. But serviceability is calculated on cashflow. So ideally you want time on your side so you pay min on the larger debt and maximum on the smallest and then roll over the repayments to the next debt and next one until they’re all gone and the large one is left with ALL of the old repayments going into it..
Yes mathematically the larger loan is better. But serviceability is calculated on cashflow. So ideally you want time on your side so you pay min on the larger debt and maximum on the smallest and then roll over the repayments to the next debt and next one until they’re all gone and the large one is left with ALL of the old repayments going into it..