So you have decided to start paying down your debts. If you only have a mortgage that you can easily afford, this is not a problem. But if your are drowning in debt, what do you do? Let’s investigate the options you have here; the debt snowball and the debt avalanche. I will assess both debt strategies here, assisted by a case study with Jeff, who’s in quite some debt.

Meet Jeff

Jeff is a 31 year old computer programmer from The Netherlands. He’s making pretty decent money, about 50,000 euros per year. After taxes this amounts to roughly 30,000 per year or 2,500 per month in net income. These numbers are rough estimates and depend a lot on Jeff’s specific situation, but let’s go with this 2,500 per month. Jeff is certainly considered middle class in The Netherlands with his income.

But even when earning 50,000 per year (quite some above the median income), you can be in a lot of financial trouble. The point is, Jeff’s in quite some debt. He’s got some student loans, luckily at a very low interest rate, but still quite a bit of debt. Also, he is stretched to the limit on his mortgage, and has two personal loans from back when he was not as financially savvy and decided to finance traveling the world and a used car.

Student Loans

Jeff’s student loans were used to finance his student life back when he was in university. Since he didn’t have a job, he needed the money not only to pay his tuition but also fund his lifestyle. Looking back he wishes he’d got a job. It’s not the interest rate on the loans that’s killing him. No, luckily he got a pretty good deal. The Dutch government loans money to students at cost. That is the rate the government pays to borrow money. Jeff’s 0.8% is very doable, but still it’s costing him over 135 euros per month.

Mortgage

Four years ago, Jeff decided to buy a nice house for himself. He is stretched to the limit on his mortgage. The 300,000 figure is more than he can afford, but because of some clever administrations he and his financial adviser managed to get a loan that big. It had to do with counting both his income at the time and his side-hustles where he had some luck that year. His side projects had since stopped, so his income dropped quite a bit. Now he’s stuck with payments of over 1,200 a month.

Personal Loans

Very stupid, he knows. But when Jeff was a bit younger, he took on some personal debt to travel the world. Then a few years later he took out another loan, to finance a car. The loans are costing him about 300 euros per month in total.

Debt Snowball

The first debt strategy I want to highlight is the debt snowball. This method is made popular by Dave Ramsey, in his book “Total Money Makeover”. The strategy is simple, you list all your outstanding debt balances from the lowest to the highest balance, and pay them off in that order.

This is not necessarily the cheapest option, or the best way to become debt free. It is made to be easy to follow, by building in quick wins. According to Ramsey, this is important because without the quick wins it might be hard to keep going. He is right about that. When you tackle your lowest balance debt first, you can cross off a number of debts very quickly. Even if these debts are low interest, and you’re still paying high interest rates on your larger debts, it motivates to see the small balances disappear so fast.

The idea is that you keep paying all your minimum payments on every piece of debt. Then all the money you have leftover from your budget goes towards the smallest balance. As soon as that debt is completely paid off, you now allocate the minimum payment you used to have on that smallest debt towards the next one. That way, the extra payments you can make every month are growing. The debt snowball gets bigger and bigger, and as you build momentum you will take on the higher debt balances and pay them off as well.

Jeff’s Debt Snowball

So if Jeff decided to use the debt snowball to become completely debt free, including his cheap student loans and his mortgage, how would that look like? He would first list out all of his debts, from the smallest to the largest balance:

As you can see, Jeff’s almost 300,000 euros in debt, for a total debt service of almost 1,700 per month. Luckily, after reading “Total Money Makeover”, Jeff decided that enough is enough. He can live a little bit cheaper, on 1,000 euros per month excluding his mortgage payment. That leaves him with a total of 2,000 per month to accelerate his debt payments. So every month, Jeff will allocate an additional 312 euros towards his debts, and as he is targeting the smallest amount first, he’ll put that extra money towards his second personal loan.

If Jeff were to do nothing, it would take him 26 years from now on to become debt free (that’s when his mortgage is paid off) and cost him a grand total of 116,653 euros in interest from now on.

Personal Loans

By leveraging the debt snowball, Jeff will be debt free sooner. If he can allocate his additional 312 euros towards the first debt, that will increase his monthly payment from 113 to 425, and it will be paid off after seven months, instead of the 24 months that are left based on the minimum payment. This debt is paid off in 7 instead of 24 months and has saved Jeff 151 euros in interest.

After those seven months, an additional 113 euros will be freed up in his budget. That means that Jeff can now allocate 425 extra euros towards his next smallest debt, the first personal loan. At the start of his debt pay off strategy, 48 months were left on this loan. With the additional 425 euros from month 7, he will pay off the debt in month 19 instead of month 48! That’s more than 2 years early, and it will save him 784 euros in interest.

Student Loans

Now that his personal loans are both gone, Jeff has an additional 622 to put towards his next goal, his student loans. At this point in time, month 19, just over a year and a half after he decided to become debt free, Jeff has over 9,500 left on his student loans but will pay them down with a total payment of 758 euros per month. That way, he will get rid of his student loans in month number 32. That is is more than 5 years early, and again saves him quite a bit of money. In total, he saved 286 euros on his student loan by paying them off early. This number is quite low, because of the low interest rate on the loans.

And Finally: Jeff’s Mortgage

But no matter how low the rates were, an additional 136 euros are freed from Jeff’s budget so he will have a grand total of 2,000 euros per month to attack his mortgage. At this moment his mortgage balance is about 250,000 and with the accelerated payments (2,000 vs 1,242) he will be completely debt free in month 184, or just over 15 years after he decided to get out of debt. Jeff now has paid off his mortgage after 19 years, and saved over 50,000 in interest on his mortgage.

Jeff is now 50 years old and completely debt free. If he did not decide to pay off his debts, he would have paid an extra 51,000 euros over his lifetime and be debt free at the age of 61. This is the power of the debt snowball, and remember, Jeff only allocated an additional 312 euros towards his debts. That’s not a lot of money, but it saved him over 50,000.

Now we’ve seen the power of the debt snowball, lets run the numbers on the debt avalanche!

Debt Avalanche

The debt avalanche is a debt strategy used to get out of debt faster, and save more money, than when using the debt snowball. The core strategy here is to attack the highest interest rate debt first, so that in total you save more money. However, this strategy is not for everyone. For example, when your high interest debts also are the highest balances, it might take a while for you to see the first wins. That means the debt avalanche is more difficult to stay on track.

Also, you need more liquidity to pull off this debt strategy. With the debt snowball, you’re constantly freeing up additional cash flow by paying off debt. With the debt avalanche it takes longer. That means you need to be sure of your liquidity, so that you can sustain longer periods of time of high payments.

Let’s see how Jeff would do when using the debt avalanche to pay off his loans.

Jeff’s Debt Avalanche

So now we know that Jeff needs to list all his debts from the highest to the lowest interest rates, we get the following order of debts to pay off:

Personal Loans

So this time, Jeff starts allocating his additional 312 euros towards his first personal loan, the one with the highest (5.3%) interest rate. That brings the total amount he pays to 509 euros per month. At this pace, he pays off Personal Loan 1 in month 18 instead of 48. That saves him a total of 797 euros in interest.

His leftover money that will be allocated towards Personal Loan 2 is now 610 euros per month. Because this loan had only 24 months to go when Jeff started, it is almost paid down already. However the additional payments still make a difference, since the loan will be paid off completely in month 19. The savings here are minimal, but still 59 euros.

Mortgage and Student Loans

Now the big mortgage is the first one to go. Jeff will put an additional 622 euros per month towards his mortgage, paying 1,864 in total every month. He expects this loan to be paid off in month 182, or just over 15 years. By paying so much additional money towards his mortgage, Jeff saves about 49,207 euros in total.

Because paying down his mortgage took him longer than the time left on his student loans, he never paid extra towards the student loans. Somewhere halfway into his mortgage, the student loans were gone and the additional money was added to bring his mortgage payments up to the full 2,000 euros.

Debt Avalanche Results

So, using this debt strategy of the debt avalanche, Jeff paid off all of his loans a little bit earlier than with the debt snowball strategy. The difference is not that big, just 2 months. The reason for that is the relatively low combined interest rate on the loans. If for example the student loans had a higher interest rate, the difference would have been bigger. In that case the high rate student loans would not have been paid off first with the debt snowball, as Jeff was focusing on the lower balance personal loans.

Which Debt Strategy Should I Use?

When you decide to pay down your debts you can decide which debt strategy you’ll use. If you do have a lot of additional money, it’s wise to attack your high interest loans first. That will save you more money in the long run.

You can also pay off the smallest debts first. That will free up extra cash flow every month and you will be motivated by the quick wins that you will make.

Did you pay off a lot of debt? Let me know how you did it in the comments below. I’m very interested in seeing more examples of these debt strategies in action. Also, I would like to do a case study. If you want me to help you think through some strategies, let me know. You don’t have to pay me anything. The only thing I ask from you is that I can use the case study for a blog post (anonymously if you wish).