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Debt Reduction Methods and Philosophies: Snowball, Avalanche and More

This article was written by in Debt Reduction. 19 comments.


When someone who has accumulated debt across a number of credit cards embarks on the journey to rid himself or herself of this debt, and when that person is generating enough monthly income to cover all expenses and the minimum payments due on all cards with additional funds left over, there are two main philosophies describing the best way to achieve this goal. Although all approaches are good, there is no question where I stand on this issue.

I suggest following the path that affords the opportunity to get rid of debt as quickly and as cheaply as possible. This method has many names, but I’ve called it the Debt Avalanche in the past. The opposing viewpoint is the Debt Snowball, popularized by author and guru Dave Ramsey. This method suggests paying off debt in such a way that it might take more time and be more expensive but offers “quick wins” which help some people gain encouragement and momentum at the earliest stages of the process. And there are, of course, many points of view that present a compromise between these two extremes.

The snowball approach to debt reduction

By ordering your credit card debts from lowest balance to highest balance and paying the minimums to all except the first on the list each month, you will pay off your first debt sooner than by following any other method. If you need encouragement to continue your journey as you pay off debt, you can celebrate after your first credit card has a zero balance.

Not everyone requires this type of extra motivation for paying off debt. Additionally, even those who need extra motivation may not suffer by choosing a cheaper and quicker method of paying off debt. The “quick win” of paying off the first debt could come just as quickly by using the Debt Avalanche. But even if the first payoff doesn’t come as quickly, you can redefine your first milestone to allow yourself helpful celebrations as explained in the next section.

J.D. Roth from Get Rich Slowly has seen success with the Debt Snowball approach, as have many others. It is the most widely marketed philosophy.

For an illustration of the monthly process of sending minimum payments to all credit cards except the one on top, regardless of how the debts are ordered, see this visualization from No Credit Needed.

snowball3

One major problem I have with the above snowball approach is that your largest balance may be significantly more expensive than your smallest balance. Today it is not difficult to find a default interest rate on a credit card north of 30%. There is no way in good conscience I could recommend holding off on eliminating a debt this expensive in favor of paying off a small balance with a 7.9% interest rate. The same goes for payday loans, whose fees can border on usurious if interpreted as interest rates.

The avalanche approach to debt reduction

There is no question that anyone who follows this alternate approach to its conclusion will have emerged from debt sooner and by paying the least amount of interest possible. Some people argue that it is not as likely for someone to follow the Debt Avalanche through, but there are no data to support this. By ordering your credit card debts from the most expensive (highest interest rate) to the least expensive and paying the minimum each month to all cards except the first on the list, you reduce your interest payments quicker.

Since this is a mathematical approach, critics say it doesn’t take into account the emotions that come into play when dealing with money. It is true that emotions — your feelings about money — play an important role in financial decisions, and although this is a mathematical approach, how you feel about money still is represented in this method.

  • If you follow the Debt Avalanche method, you can feel good knowing that you’ve made a sound decision and will spend less money than others who take a different approach.
  • You can motivate yourself throughout by creating your own milestones for achievement, including paying off your first credit card, paying off $1,000 (or some other meaningful amount), or consistently reducing debt for six months (or some other meaningful time frame).
  • Your emotions may be the cause of your debt in the first place. While they obviously cannot be eliminated, learning to focus on the best mathematical approach for certain financial decisions can improve your overall relationship with money.
snowball4

Here I outlined the details of the Debt Avalanche. Trent from The Simple Dollar also likes the Debt Avalanche approach and Five Cent Nickel explains how Dave Ramsey is bad at math.

Other approaches to debt reduction

The hybrid approach. Somewhere between a snowball and an avalanche lives this hybrid. The concept here is simple. Order the credit cards from highest interest rate to lowest, like the Debt Avalanche, but move the card with the lowest balance to the top. This will provide a “quick win” if necessary but could still save significant money and time when compared to the Debt Snowball approach.

Pay the most annoying debts off first. This approach plays directly into the human psyche. The urge to eliminate a persistent itch is strong enough to motivate anyone to scratch, just ask any kid with chicken pox. Stephanie from Poorer Than You is a fan of this approach. This works well when you include debts other than credit cards. If you have a personal loan from a family member, I usually suggest paying that debt off the quickest while paying minimums to your credit card to help retain good will within close relationships.

Baker from Man vs. Debt says the same thing slightly differently: Pay off the debt with the highest emotional impact first. The argument here is simple. For some people the debts with the highest emotional impact are simply the debts with the highest interest rate, while others have a different psychological composition requiring alternate focus. You can’t go wrong by this approach which if continued will help you feel better quicker.

So what is the “right” answer?

It is easy to say, “Do what works for you,” and allow the debtor to come to his or her own conclusions. This can be a dangerous approach as it invites people to skip the consideration of all the options. Many people I’ve talked to who have successfully eliminated debt by using the Debt Snowball method not only found themselves back in debt after some time but did not realize that they could have saved hundreds of dollars and been out of debt sooner just by ranking their credit cards in a different order. They simply followed a guru’s advice without any critical thinking. Not only did they not learn to approach money from a more stable viewpoint but they paid extra money in the form of credit card interest for this “feature.”

Would they have succeeded if they were simply presented the idea that they could save money on their debt reduction journey by following a more mathematical approach? It’s certainly possible.

There is no approach that does not have some sort of merit. Getting out of debt in any way possible is better than not getting out of debt at all. All that I ask is that the details, including the total cost and time differences, are fully explained before a method is prescribed for someone else.

Here’s a calculator that will help inform anyone in debt about the timing and bottom-line differences between the various approaches to eliminating debt. In some cases, the cost of one method over the others will be striking.

An informed decision is the best type of decision. With a full understanding of the differences and is familiar with their own psychological tendencies, someone with debt can make an intelligent choice that is right for the individual or family.

Photos: House of Sims, Joe Shlabotnik

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The College Education Bubble and Crash

This article was written by in Education. 13 comments.

A new survey takes a look at the critical state of today’s recent college graduates. The survey questioned a nationally-representative sample of 444 recent college graduates between the ages of 22 and 29, about their employment situation and experiences. The questions also lightly touched upon these graduates’ financial condition. I’ve included a link to the full survey at the bottom of this article.

The necessity of choosing a major in college can put quite a bit of pressure on any student, particularly those who have either a wide variety of interests and talents as well as those who may not feel themselves pulled in any particular direction. There’s always the hope or the expectation that the bachelor’s degree will define a career path for the rest of one’s life, and that career path will follow a straight line or an exponential curve.

GraduationAn economist’s opinion is that students, who often go into debt to obtain their degrees, should simply look at the expected rate of return. I can’t tell you how many times I’ve heard or read that students should choose majors like engineering, physics, computer science, or applied mathematics to guarantee high salaries and easy job placement. Not everyone is interested or talented in these areas, and the pure financial approach says that those who aren’t shouldn’t bother spending money for a college education. The return on investment for an education is about more than just money, but that opinion doesn’t exactly make me popular in certain communities.

The financial reality is dire according to this survey. And as much as a college education has value beyond the expected return in the form of salary, no one can ignore the money-related part of the equation. Many decades ago, a college degree was a sign of differentiation, and gave holders the ability to market themselves well and qualify for the best jobs. At the same time, culture put such an emphasis on higher education that as it became available to more people — through grants and loans, not through lowered costs — it’s become less of a distinction. Colleges are basically unchecked in their tuition increases because they know that students will keep coming and the government will continue providing opportunities.

In good economic times, that can be ignored. With a low level of unemployment among graduates, former students can receive jobs, healthy incomes, and can pay down their student loan debt. In difficult times — when Baby Boomers aren’t retiring and there aren’t opportunities for younger workers, for example — the buy-now-pay-later model of education begins to fail. And it always fails for those with degrees in fields that take longer to recover their costs, like the arts and humanities.

Mark Cuban offered an apt analogy. College education is similar to the practice of flipping real estate. In the heyday of oversized, abnormal growth in the real estate market, any fool could make
money by buying a house relying heavily on debt, selling it to a bigger fool, and using the proceeds to repeat the process. There was a promise of success, and it worked well for a while — until the real estate market meltdown, followed by the Great Recession and credit crunch. A similar experience is happening today with the investment in a college education. Cuban argues that it used to be able to “flip” a college degree for a good starting salary and a solid opening to a life-long career, but the investment no longer performs so well.

With the run-up in real estate prices, it became very easy to access credit. Banks would give loans to as many customers as possible, with the knowledge the banks could repackage and sell those loans to reduce their apparent risk. The credit crunch required banks to tighten up their lending standards to the point where credit wasn’t available anywhere. Cuban believes this is where we are heading with student loans.

Years ago, policies were designed to ensure that everyone who wanted to become a homeowner could afford to do so. Taxpayers subsidized a great expansion in homeownership, and the real estate industry thrived. Education for all has been just as much a part of the American Dream, and taxpayers are subsidizing college educations for those who can’t afford it on their own. When it’s so easy to get an education for little money down, and everyone is taking advantage of free-flowing credit, we should have expected that making a return on that investment has become more difficult.

There is more student loan debt in aggregate in the United States than credit card debt, and Mark’s conclusion is that the economy won’t improve until this student loan bubble bursts. He promotes non-traditional universities — though not diploma mills, as he later warns — as the answer, because they can provide a better deal.

While colleges and universities are building new buildings for the English, social sciences and business schools, new high end, un-accredited, branded schools are popping up that will offer better educations for far, far less and create better job opportunities. As an employer I want the best prepared and qualified employees. I could care less if the source of their education was accredited by a bunch of old men and women who think they know what is best for the world. I want people who can do the job. I want the best and brightest. Not a piece of paper.

The competition from new forms of education is starting to appear… You would think traditional university educators would take notice. Beyond allowing some of their classes to be offered online, they haven’t. They won’t. Its the ultimate Innovators Dilemma. They don’t believe they should change and they won’t. Until its too late. Just as CEOs push for that one more penny per share in EPS, University Presidents care about nothing but getting their endowments and revenues up. If it means saddling an entire generation with obscene amounts of school debt, they could care less. This is how they get their long term contracts and raises.

It’s just a matter o[f] time until we see the same meltdown in traditional college education. Like the real estate industry, prices will rise until the market revolts. Then it will be too late. Students will stop taking out the loans traditional Universities expect them to. And when they do tuition will come down. And when prices come down universities will have to cut costs beyond what they are able to. They will have so many legacy costs, from tenured professors to construction projects to research they will be saddled with legacy costs and debt in much the same way the newspaper industry was. Which will all lead to a de-levering and a de-stabilization of the university system as we know it.

Just over half of recent college graduates have jobs. Many of those who do have jobs settled for a position for which their four-year degree was not necessary. 40 percent of recent graduates haven’t even begun paying off their student loan debt. Most recent graduates, while happy with their time in college, would have chosen a major after more consideration, taken different courses, or sought out more working or internship opportunities.

Photo: NazarethCollege
Blog Maverick, John J. Heldrich Center for Workforce Development

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Tavis Smiley: Poverty Is a Threat to Democracy

This article was written by in Economy. 17 comments.

Tavis Smiley and Dr. Cornel West have been working hard to bring the issue of poverty into the consciousness of the citizens and political discourse of the United States. As a team, Smiley and West have been touring city to city, speaking to audiences concerned about the increasing wealth gap in this country. Their book, The Rich and the Rest of Us: A Poverty Manifeseto, is the culmination of their observations of American citizens throughout these travels.

While the economy is technically in recovery from the Great Recession, a vast slice of Americans have not experienced a real recovery. A “jobless recovery,” where the beneficiaries of an improving economy are the wealthy while the middle class struggles with unemployment, is not a real recovery. Despite this disadvantage, the prevalence and pervasiveness of poverty is still astonishing. According to Smiley and West, 150 million people in this country are in or near poverty. That number represents one out of every two individuals — half the country.

Tavis SmileyThe issue of poverty, affecting this number of individuals, is bigger than poverty itself. The government tallies 46 million Americans living in poverty according to the 2010 census and the government’s own definitions of poverty. Many more individuals are affected by poverty because they are living dangerously close. Many middle class households, particularly those already living in debt or in a paycheck-to-paycheck situation, are one lost paycheck away from a dangerous financial situation, and many families are already experiencing a personal decline due to the inability to find gainful employment.

Poverty has traditionally been a problem classified as urban or rural. Minorities have been and are disproportionately affected by poverty, but poverty is not a suburban problem, too. With white, middle-class families now facing the issue of poverty, whether by losing a job or being dangerously close to not being able to afford their homes, the issue is gaining more attention. While poverty is making life difficult for an increasing number of Americans, those in or seeking office, whether Democrats or Republicans, are not concerned. In order to receive a voice in political discourse, you need money. While the United States may have been founded on the ideals of freedom and liberty, these have generally only been granted to an elite selection of its inhabitants. The distribution of social power is expanded only by revolution among the disenfranchised.

Smiley and West contacted Consumerism Commentary with an interest in speaking to me about these issues — to defend their position, and to open my eyes to the realities faced even by the middle class in this country, many of whom are the “new poor.” We arranged an interview for the Consumerism Commentary Podcast, airing Sunday, May 13. Unfortunately, Dr. West was unable to participate in the interview at the last minutes as he was in New York waiting for a verdict after a conviction related to a political protest in that city. Tavis Smiley was able to participate, but our time together was short. We weren’t able to address all the questions I had prepared, but the discussion was valuable.

Listen to the entire discussion with Tavis Smiley, podcast host Jay Frosting, and myself, Luke Landes, once it is available this weekend. Smiley is the host of Tavis Smiley on PBS and The Tavis Smiley Show on Public Radio International. Update: Listen to the podcast here.

In the interview, Smiley dispelled many of the myths about poverty. One such myth is the idea that those in poverty are entirely to blame for their financial situation.

On Consumerism Commentary, I’ve written that taking personal responsibility for your decisions, financial and otherwise, plays the biggest role in achieving financial security and independence. This is today’s American promise: “Anyone can make it in America.” The media love rags-to-riches stories, even if it doesn’t reflect a reality for the majority of Americans. It’s true that this country’s brand of capitalism is favorable to the situations European immigrants left behind. Religious intolerance, a caste system based on ancestry, and an economic system wherein generally only the first-born male would have rights to any property drove pioneers to create a new society or join a country with a promise to create a better life for yourself. Never mind that doing so displaced others who occupied the land here.

Even in this new society, you had to be a member of the elite to receive the rights as endowed. Not everyone begins on equal footing. The lack of early educational opportunities throughout this country is one of the strongest causes of generational poverty. As Smiley addresses in the podcast, Washington state is the home to large multi-national corporations, providing a huge advantage to those who reside in Washington thanks to the tax these companies pay. The educational opportunities in Washington state far outshine the opportunities in Washington, D.C., for example. Until a quality education for the entire country is given priority, generational poverty will continue to exist.

In the interview, we also address the issue of austerity. The concept of reducing the deficit and national debt is and should be a high priority for policymakers, but the timing of austerity measures, such as reducing funding to societal programs, is just as important. Smiley argues that we cannot cut the budget for these important issues when the economy is not “flowing,” saying that the budget is being balanced on the backs of poor people. Budgets are moral documents, and you can determine a country’s real priorities by evaluating where the money is going. If this country does not address the economy for the 99 percent — those who have seen no benefit from this “jobless recovery” — rather than the “1 percent,” Smiley warns of the downfall of the United States as a world leader.

No empire in the history of the world that at some point did not falter or fail. Every empire had its day. Americans don’t want to think we could be dangerously close to the edge… Poverty is the moral and spiritual issue of our time.

Time did not permit us to explore all the topics I would have liked to cover in the interview with Tavis Smiley. For example, I would have liked to talk more about the Occupy movement and getting a national stage for the issue of poverty. In recent weeks, civil rights are again receiving national attention, from the perspective of same-sex marriage. Not to minimize that issue of equal treatment under the law for all individuals, poverty deserves the same attention from our nation’s leaders.

Be sure to subscribe to the Consumerism Commentary Podcast to hear the interview with Tavis Smiley, where we address more topics related to poverty than are outlined above, as soon as it is available. Be sure also to read The Rich and the Rest of Us: A Poverty Manifesto. Update: The interview is now available as a podcast here.

Photo: DC Central Kitchen

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Consumers Want Easier Online Payments

This article was written by in Consumer. 9 comments.

Yes, it’s frustrating to need to reach for my wallet and type in my credit card number every time I want to complete a purchase online. According to a recent MasterCard and Harris Interactive survey, 58 percent of consumers agree with me. Consumers even abandon their online shopping carts when the check-out process requires too much effort.

That might be good news for consumers. If a small barrier is all it takes to prevent someone from making a purchase, perhaps that purchase was not a necessity. Leaving more money in the bank rather than spending that money on some product that does not drive enough desire to get through a relatively painless process can only be beneficial to the shopper’s financial condition. Retailers, on the other hand, will obviously see consumers’ lack of purchase consummation as a problem, directly affecting sales and revenue.

The solution is to store the details pertaining to your payment method so it can be automatically retrieved at the point of sale. Amazon.com is certainly a pioneer with this approach. This company’s one-click purchasing process using stored credit card or debit card information makes buying a smooth process, although it created an uprising about patents when this feature was introduced many years ago.

PayPal has a good solution as well. Stores that allow payments through PayPal enable users to associate a credit card and avoid the need to type in a credit or debit card number each time.

Consumers can also use browser add-ons or downloadable programs, like LastPass, to store credit card information retrievable with a click or two.

Purchasing items online is much safer and more secure than being out in the world, carrying a wallet with all your credit cards and cash, and handing your credit cards to a waiter or gas station attendant who disappears for several minutes. Online security, as long as you confirm you are visiting a secure website, is trustworthy. No one is going to intercept my secure internet connection when I’m buying something online, and for the most part, I trust companies not to expose a database of credit card numbers to the public. That exposure is just as likely to happen when shopping in brick-and-mortar stores as when shopping online. The situation is unlikely, and shopping online does not add to that risk.

There is no universal solution, a one-click purchasing experience like that on Amazon.com, available to all retail websites. But there is also no equivalent to the one-click purchasing experience when you shop in store locations, either. Swiping a payment card or transmitting a secure wireless signal from your mobile phone gets close to the experience, but you still need to take out your wallet or your phone.

While retailers want to make it easier for consumers to pay money, consumers should be careful about making this process to automatic. Trading money for an object of some type should involve at least some opportunity to stop and consider the purchase. Technology makes it incredibly easy for consumers to part with their cash or increase their debt burden, and retailers want to make it easier. Consumers should be working against that trend and moving in the opposite direction.

If not, retailers will soon be able to simply reach into consumers’ pockets and take that money. Some companies offer free trial periods for their products and services without making it blatantly obvious that customers will be charged at the end of the trial period. Some create significant barriers to canceling the service in advance of the ending of the trial period. Consumer groups often criticize these policies, and some might be considered scams. If consumers make it increasingly easy to give up money without thought, then we’re just as much to blame.

Photo: Håkan Dahlström
BusinessWire

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Review of ING Direct’s Remote Deposit

by Flexo
ING Direct

Several readers contacted me yesterday with this piece of good news. After months of promising its customers to launch the new feature soon, ING Direct now offers remote check deposit. The delay was likely caused by the efforts that resulted in Capital One purchasing ING Direct USA. Previously, in order to deposit a check into ... Continue reading this article…

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Podcast 156: Financial Intelligence

by Flexo

Today on the Consumerism Commentary Podcast, Jay Frosting speaks to Joe Knight, co-author of Financial Intelligence: An Illustrated Guide to Knowing What the Numbers Really Mean. They discuss why and how employees in non-financial roles should learn to read financial statements, largely because accounting relies on a lot of educated guesses and biases. Consumerism Commentary ... Continue reading this article…

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How to Be a DIYer Without Time or Talent

by Gerri Detweiler

This is a guest article by Gerri Detweiler. Gerri is the host of Talk Credit Radio and serves as Director of Consumer Education for Credit.com. She is the author or co-author of five books, including Debt Collection Answers: How to Use Debt Collection Laws to Protect Your Rights. Her next DIY project is to (finally!) ... Continue reading this article…

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Do Multilingual Individuals Earn More Money?

by Flexo

A recent article in the New York Times (linked below) synthesizes several studies about people who speak several languages fluently. I am relatively confident that the ability to converse in more than one language adds to your human capital, increasing the likelihood of earning more money over time. There are some surveys that show that ... Continue reading this article…

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