Okay, so you’ve decided you want to start paying off your loans more aggressively – that’s great! The next step is to develop your strategy. This includes how much extra money you want to dedicate to making prepayments and how to prioritize which loans are paid off first.
The two most common strategies for paying off debt are debt avalanche (targeting loans with the highest interest rate first) and debt snowball (targeting loans with the lowest balance first). With both of these methods, the assumption is that as loans are paid off, that monthly payment gets applied to the next prioritized loan.
Financial expert Dave Ramsey shared his personal opinion in an article for Foundations U, “The math seems to lean more toward paying the highest interest debts first, but what I have learned is that personal finance is 20% head knowledge and 80% behavior. You need some quick wins in order to stay pumped enough to get out of debt completely.”
Strategy 1 - Debt Avalanche
Target loans in order of high to low interest rates. This method saves the most money (by reducing the amount of interest being paid over the life of the loans). Psychologically though, it can seem daunting if that highest interest rate loan is also one of your highest balances. In that case, you might decide to start with snowball and get some momentum going.
Pros
Most efficient
Save most money
Cons
Harder to see results
Less motivating
Strategy 2 - Debt Snowball
Target loans in order of smallest to largest balance. While less efficient in terms of time and money saved, debt snowball can be help borrowers build momentum in paying off their loans by quickly paying off the smallest loan.
Pros
Quick visible results
Gain momentum in debt repayment
Cons
Pay more interest than avalanche
Takes more time to finish paying off loans
Let’s take a look at both strategies using the loans below as an example.
Snowball vs Avalanche Example
Original Repayment Plan
Interest Paid - $ 3,815
Term - 120 months
Now, you decide to take a more aggressive approach and put an extra $100 towards your loans each month.
Debt Avalanche
Interest Saved - $2,206
Time Saved - 61 Months
Debt Snowball
Interest Saved - $1932
Time Saved - 60 Months
In this example, those extra $100 payments save between $1,932 and $2,206. That impact can be much more significant, especially with higher balances and/or higher interest rates. Check out both strategies with your own loans with APAY. We offer in-depth analysis and calculations to help you create and (soon) implement your custom repayment strategy.
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