Student Loans: Which Strategic Payment Method Is Best?
Two of the most popular approaches to paying off student debt are the debt avalanche and debt snowball method. Which is best for your financial situation?
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Here’s how each strategy works and how to decide which method you should use to eliminate your student loans.
What’s the Debt Snowball Method?
The debt snowball is a pretty popular strategy for repaying student loans.
A borrower starts by paying loans with the smallest balances in full and contributing minimum payments toward any other debts. Once they pay off this small balance, the borrower moves on to the loan with the next highest balance and pays it off.
They keep going, or “snowballing,” until all the small debt is paid off and they are left paying off debt with the biggest balance.
What makes the debt snowball method so popular is it’s considered a psychological attack on debt. Paying off small pieces of debt allows borrowers to earn financial wins. It helps boost their confidence and keeps the momentum going to pay off the rest of their debt.
What’s the Debt Avalanche Method?
The debt avalanche method can be quite different than debt snowball. Borrowers who choose this repayment strategy start by targeting debt with the highest interest rate, regardless of balance. They work to pay this debt in full while making minimum payments on any other debts. After the loan with the highest interest rate is paid off, borrowers move on to the piece of debt with the next-highest interest rate and work their way down from there.
For example, let’s say a borrower has three outstanding student loans with 3%, 5.5% and 8.5% interest rates. In a debt avalanche situation, they would start paying off the loan with the 8.5% interest rate first. Once this loan has been paid off, they would move on to the loan with a 5.5% interest rate. They would save the loan for 3% for last.
Often, what makes debt avalanche less appealing than debt snowball is its lack of quick financial wins. However, debt avalanche does offer intangible psychological lifts to its borrowers.
Debt avalanche focuses on tangible numbers and acts as a purely logical repayment strategy. A borrower might spend some time working to pay off a loan with a high interest rate. However, the borrower is actually saving money and time. Paying off debt with high interest rates first means this piece of debt can no longer accrue interest against the borrower.
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Helpful Tips for Determining Which Method To Implement
Debt snowball or avalanche: which repayment strategy should you use to pay off your student loan debt? The answer depends on your financial situation.
Before using either repayment strategy, borrowers should consider how much student debt they have and what the interest rate associated with each form of debt looks like. If a borrower notices they have what is referred to as sore thumb debt — debt with an unusually high interest rate or unusually low balance — they may use a targeted payment to address that outlier debt first.
What if there is no sore thumb debt and the borrower just has several loans with various interest rates? Consider getting in touch with a trusted financial advisor for an analysis.
Financial advisors have tools to model out different repayment strategies for different loans. These tools can better recommend which repayment strategy to use for your debt and help borrowers choose a repayment method that works best for their circumstances.
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This article originally appeared on GOBankingRates.com: Student Loans: Which Strategic Payment Method Is Best?
