Pros and Cons of Debt Reduction Methods

DebtGetting yourself buried under a mountain of debt can leave you feeling overwhelmed. But there are ways to dig yourself out. The most common debt reduction strategies are the snowball and avalanche methods. But you can also use a less well-known method, called the `tsunami.` Each method has pros and cons as to how fast and how well you can reduce your debt.

Snowball

The snowball method of debt reduction involves paying off your smallest debt first, regardless of the interest rate.

For example, say you have three credit cards, one with a $500 balance and 15 percent interest rate, one with a $1,200 balance and 10 percent interest rate and one with an $1,800 balance and 19 percent rate. In the snowball method, you would make minimum payments on the two largest debts and concentrate all the extra money you can afford on the smallest debt until it is paid off. Once that debt is paid off, you commit the money you were paying to the next-largest debt. The momentum you achieve in paying off debt is like a snowball rolling down a hill that gets bigger and bigger as it picks up more snow, hence the name.

The advantage to the snowball method is that it allows you to get one of your debts paid off quickly, thereby reducing the number of bills you have to pay. It also offers a psychological advantage in that you see your bills shrink quickly, which gives you a positive feeling.

The biggest disadvantage is that you don`t pay attention to interest rates, so you might pay more in finance charges in the long run than if you had focused on paying off the debt with the highest interest rate first.

Avalanche

When you follow the avalanche method of paying off debt, you target the debt with the highest interest rate, regardless of how much you owe. Following the earlier example, you would make minimum payments on the $500 and $1,200 balances and pay the maximum you can afford on the $1,800 balance. Once that balance is paid off, you would then concentrate on paying off the $500 balance, since it has the next-highest interest rate.

The advantage of the avalanche method is that by targeting the debt with the highest interest rate, you reduce the amount of potential finance charges you might pay. The disadvantage of such a strategy is that it might take a long time before you get a single debt paid off, which can be inconvenient as well as depressing. If you don`t see progress, you could get discouraged and get off track.

Tsunami

The tsunami method of debt reduction involves concentrating on first paying off debts that have some kind of emotional issue attached. Perhaps one member of a couple used a credit card to buy a lot of frivolous things, such as a big-screen TV or lots of designer clothes and shoes. Because of this, the debt might be a source of constant friction between husband and wife or boyfriend and girlfriend. Concentrating on paying off the debt, whether it is large or small or has a high or low interest rate, could remove a source of friction in a relationship.

Of course, the disadvantage of this method is that it may not make financial sense. Your most emotionally charged debt may be the largest debt with the lowest interest rate, so you may wind up neglecting other debts that it would make much more sense to pay off first. While the debt tsunami method of paying off debt can be a good choice emotionally, it may not make for a sound financial strategy.

Whatever debt reduction method you decide to use, you need some kind of a plan if you are drowning in debt. You can find a calculator and other tools to help with debt management and debt reduction at National Debt Relief.

 

About Kimberly Howard, CFP, CRPC

Kimberly J. Howard, CFP®, CRPC®, ADPA® is the founder and owner of KJH Financial Services in Needham MA, Newton MA and Denver CO. She enjoys helping clients explore and achieve their life goals through effective comprehensive financial planning. Kimberly holds a Master of Science degree in Computer Science Information Management from Boston University. She earned a Bachelor of Science degree in Mathematics and Physical Education from Stephen F. Austin University in Texas. She attended Boston University for her Certification in Financial Planning and H&R Block for Tax Preparation Certification. Kimberly is currently an adjunct faculty member at MetroState University where she teaches General Financial Planning Principles, Income Tax, Retirement Planning and Estate Planning. She is a past adjunct faculty member at Boston University and The College for Financial Planning. Kimberly is a member of the Financial Planning Association (FPA) and The National Association of Personal Financial Advisors (NAPFA). She was named to the Metropolitan Who's Who Among Executive and Professional Women. She is an expert Advisor for Nerdwallet, BrightScope, Morningstar, and FiGuide. Kimberly promotes a life planning approach with a balanced work/life style. She is active in sports including cycling, golf, skiing, and hiking.
This entry was posted in Budgeting, Debt Management and tagged , . Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s