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I recently read an interesting article on Debt Avalanche? Correct?, this article was an examination of which method is best for repaying credit card debt. It examines two distinct methods; the debt avalance method and the debt showball method.

What I found from reading the article and both methods is that it doesn’t take into account interest, so I thought I would do a more in depth look at this situation using some real numbers, and also take into account the effect that minimum payments have on your strategy.

I’ve taken the numbers used on the BeatingBroke example, however I’ve slightly modified the minimum payment for one of the cards, as in his example the minimum payment was less than the monthly interest, which is not possible with a credit card – or if it is allowed in the states, then that does explain the credit crisis…

So we’ll start with Joe Bloggs, who is in my example a twenty something who’s started to take his finances seriously and decided to pay off his credit cards. He has decided that each month has an extra £300 that he could “overpay” his credit card balances. He has the following cards with the following balances, interest rates and minimum payment amounts.

	Balance	Int % (annual)	Min Payment %	Initial Min Payment
Card A	£850	8.99	3.5%	£29.00
Card B	£2,000	11.00	2.25%	£45.00
Card C	£3,500	27.99	2.5%	£87.50
Card D	£5,000	10.00	2%	£100.00

 

Method 1 – Debt avalanche

This method states that you should arrange your debts in order of highest interest rate and repay the highest rate off first and descend through to the lowest rate.

Method 2 – Debt snowball

This method states that you should pay off the smallest balance first, so as to get a sense of achievement early on, then work your way up ascending through to the largest balance last.

I’m a bit of a numbers guy so I have used a spreadsheet to work out in our example which method is the best. I’ve assumed that for each card, the initial minimum payment is made regardless of what the minimum payment would be as specified by the card provider.

I have found that when interest is included, the debt avalanche method pays the cards off one month quicker than the debt snowball method. There really is not a great deal to choose between the two methods.

I wonder what would happen if the figures were different though. What would happen if the balances were significantly higher for a couple of the cards? What would happen if the minimum payments were different for each card?

There is also another method to use to repay the debt, which is simply putting all the cards onto their minimum payment each month, and using the excess that would have been spent on a fixed minimum payment to overpay the card that is being targeted.

What I will do, is using the figures from the initial example, build a model that tests both the snowball method and the avalanche method to see which model works best, when combined with my method, which I’m going to call the single focus method.

The results of my spreadsheet are that by using the single focus method, you will pay off the debts one month earlier using the new method, however, you do pay more interest during the course of paying the debts off. Not a huge amount of extra interest, in fairness. I suppose it’s a trade off between paying more interest or paying the debts off quicker.

In reality though, you would have to be very anal to actually set this up, and it would be much easier to simply use the debt avalanche method as that requires much less mathematical/spreadsheet ability. Only if the debts were significantly larger would it be worth using this more complicated method, as the savings in interest would become more significant with a larger amount of debt.

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