Understanding The Difference Between Debt Avalanche And Debt Snowball In Canada
Modern captives are not in chains. They are in debt. Indeed, this statement is correct. It represents the sorry state of millennials indebted. Paying off a sizeable chunk of your monthly income in EMIs (Equated Monthly Instalments) is burdensome and harsh. It led to several debt management strategies, helping you settle your outstanding balances quickly.
Source: Freepik
Debt avalanche and debt snowball are some of these strategies to discuss. Here is everything that you must know to clear your dues swiftly.
When Do These Strategies Come into Play?
It is pertinent to note that you need both debt avalanche and debt snowball in situations when:
- You owe multiple debts, such as car loans, student loans, Credit Card Debt, Line of credit, etc.
- All these loans have different:
- Outstanding amounts
- Interest rates and
- Tenures
- You want to pay off your debt quickly and want to get free sooner than later
Further, you cannot use these strategies with mortgage debt because:
- It has a high amortization period that ranges from 10-years to 30-years
and
- It is the cheapest kind of loan as it bears a very low-interest rate compared to the other forms of loan
What Is the Strategy of Debt Avalanche in Simple Language?
What hurts you the most while paying off your debt? Undoubtedly, it is the interest cost. The higher the interest rate, the more financially adverse it is for you. “Debt avalanche” focuses on this aspect and targets those debts first in which you are paying a high-interest rate.
Process of Debt Avalanche Method
Let us understand the several steps involved in the process of Debt Avalanche:
- You will prepare a list of all your debts in a descending order wherein your most expensive debt [having the highest interest rate or APR (annual percentage rate)] will come at the top
- You will earmark a portion of your monthly income for paying off your debt liability.
- You will pay the minimum amount due on your every debt so that you are not in default.
- You will use the remaining earmarked funds to pay for the debt with the highest APR, which hurts you the most.
Advantages and Disadvantages
- One of the enormous advantages of this method is that it helps you save hundreds of dollars in interest costs as it advocates paying off that debt first, which is the most expensive.
- On the other side, you will consider debt avalanche suitable for only a few selected individuals that are highly disciplined and motivated. Not everyone prefers to pay just the minimum amount towards the cheaper debts.
How Does a Debt Avalanche Work?
Let us understand the practical working of the Debt Avalanche method through a practical example.
- Emma Tremblay is a salaried professional and is residing in the Greater Toronto Area with her family
- She presently owes several debts of varying amounts and is looking for a strategy to pay off all of them quickly
- She has earmarked a monthly sum of $1,500 that she will use to pay her dues
- Below is a list of all her debts:
| S. No. | Type of Debt | APR | Minimum Payment | Total Outstanding Amount |
| 1 | Car Loan | 9% | $200 | $12,520 |
| 2 | Educational Loan | 7% | $120 | $8,580 |
| 3 | Credit Card Debt | 24% | $50 | $2,750 |
| 4 | Unsecured Personal Loan | 36% | $75 | $6,390 |
Emma’s financial advisor, understanding her plans, recommended her Debt Avalanche Strategy and gave her the following presentation:
- He arranged Emma’s debt in the descending order from the highest APR to the lowest in the following manner:
| S. No. | Type of Debt | APR | Minimum Payment | Total Outstanding Amount |
| 1 | Unsecured Personal Loan | 36% | $75 | $6,390 |
| 2 | Credit Card Debt | 24% | $50 | $2,750 |
| 3 | Car Loan | 9% | $200 | $12,520 |
| 4 | Educational Loan | 7% | $120 | $8,580 |
- He asked Emma to pay the minimum amount towards the following loans:
| Type of Debt | APR | Minimum Payment |
| Credit Card Debt | 24% | $50 |
| Car Loan | 9% | $200 |
| Educational Loan | 7% | $120 |
| TOTAL | $370 |
- Now, Emma has $1,130 ($1,500−$370), and he asked her to use this remaining amount towards her Unsecured Personal Loan.
- Emma will pay off her Unsecured Personal Loan in 7 months. (Calculated using Credit Card Payoff Calculator)
Post this,
- Emma will target her next most expensive debt, Credit Card Debt, having an APR of 24%.
- She will again make minimum payments towards her Car Loan and Education Loan
- She will use the remaining funds to pay off her Credit Card Debt
What Is the Strategy of Debt Snowball in Simple Language?
Having understood the strategy of Debt Avalanche, which targets the debt with the highest interest rate first, a Debt Snowball first targets debt having the smallest outstanding amount. It does not consider the APR rate and ignores it.
It is more conventional and focuses on eliminating those debts first that are small. Let us now understand the process of Debt Snowball:
- You will prepare a list of all your debts in ascending order, wherein your smallest debt will come at the top
- You will earmark a portion of your monthly income for paying off your debt liability
- You will pay the minimum amount due on your every source of debt so that officially you are not in default
- You will use the remaining earmarked funds to pay for your smallest debt
Advantages and Disadvantages
- If you are looking for motivation, Debt Snowball can do this. Using this strategy, you get motivated as you see you can reduce the number of your debts quickly.
- On the other side, this technique is more psychological, and, for some, it is simply a simple decision. By ignoring APR, you might end up paying additional interest costs.
How Does a Debt Snowball Work?
Let us continue with the example of Emma Tremblay (mentioned above) and understand this technique.
The financial advisor presented her with a debt Snowball technique:
- He again arranged the debts, but this time, in the ascending order, the smallest outstanding amount came at the top:
| S. No. | Type of Debt | APR | Minimum Payment | Total Outstanding Amount |
| 1 | Credit Card Debt | 24% | $50 | $2,750 |
| 2 | Unsecured Personal Loan | 36% | $75 | $6,390 |
| 3 | Educational Loan | 7% | $120 | $8,580 |
| 4 | Car Loan | 9% | $200 | $12,520 |
- He requested Emma to pay minimum amounts towards the following loans:
| Type of Debt | APR | Minimum Payment |
| Unsecured Personal Loan | 36% | $75 |
| Educational Loan | 7% | $120 |
| Car Loan | 9% | $200 |
| TOTAL | $395 |
- Now, Emma has $1,105 ($1,500−$395), and he requested her to use these funds to pay off her Credit Card Debt.
- Emma will pay off her Credit Card Debt in 3 months. (Calculated using Credit Card Payoff Calculator)
Post this,
- Emma will target her smallest debt, which is the Unsecured Personal Loan, having an outstanding amount of $6,390
- She will again make minimum payments towards her Car Loan and Education Loan
- She will use the remaining funds to pay off her Unsecured Personal Loan
Wrapping it Up
Which one is better? Well, there is no definite answer to it. Eliminating debt based on APR (debt avalanche) works best, while some eliminate the smallest debt first (debt snowball).
Hence, gain a thorough knowledge of these debt management strategies and decide what will work best for you.
