Explain when paying off the smallest balance first is worth the extra interest.
Mei Ling has tried to pay off her credit card 2 times before. Each time she started strong, putting every spare dollar on the card, and each time she stopped after a few months because the balance still looked enormous and nothing on her list of debts had gone away.
When she read about the avalanche method in lesson 6.2, she saw she would go 20 months without clearing a single debt. That sounded too much like her two failed attempts. The snowball method is the alternative she is now weighing. It has the same structure as the avalanche but pays the debts off in a different order.
Under the snowball, you pay the minimum on every debt, every month, on time. All the extra money you have for repayments goes to the debt with the smallest balance, whatever its interest rate. When that debt is cleared, its full payment (the minimum plus the extra) rolls into the payment on the next-smallest balance. You repeat this until every debt is gone. The steps are:
List all your debts. Sort them by balance, smallest first, ignoring interest rates. Pay the minimum on every debt, every month, on time. Send all extra repayment money to the debt with the smallest balance. When it is cleared, roll its full payment (minimum plus extra) into the next-smallest debt. Repeat until the list is empty.
Snowball order is set by balance alone, and interest rates play no part in it. A S$500 debt at 4% goes before a S$5,000 debt at 26% (example figures), because S$500 is the smaller balance. The avalanche, taught in lesson 6.2, uses the same structure but orders debts by interest rate, highest first.
Mei Ling's debts are the same invented figures used in lesson 6.2: a sofa instalment plan of S$1,500 at 6%, a personal loan of S$6,000 at 8%, and a credit card balance of S$9,000 at 26%. She has S$800 a month for repayments. Sorted by balance, her order is the sofa plan, then the personal loan, then the credit card.
Each month she pays the card minimum and the loan's S$200 payment. Everything else goes to the sofa plan. In month 1 that is about S$324: the S$60 minimum plus about S$264 extra. She clears the sofa plan in month 5.
From month 6 she adds the money that was going to the sofa onto the loan's S$200, and she clears the loan in month 15. From month 16, everything that went to both cleared debts goes to the card. She clears the card in month 26.
Under the snowball she pays about S$4,155 in interest. Under the avalanche in lesson 6.2 she would pay about S$3,033 and finish in month 25, one month earlier. The snowball costs her about S$1,122 more (S$4,155 minus S$3,033). Most of that extra interest comes from the card sitting at 26% while the two cheaper debts were cleared first.
The snowball costs more in interest than the avalanche, but for some people it is still the better choice. Each debt you clear removes a bill, a due date and a statement, so the plan you have left is simpler to follow. Each one also frees a payment to roll into the next debt, and you can see that happening. The extra interest buys early, visible wins: the list gets shorter and the plan visibly works well before the end. If you have never started and stopped a repayment plan, those early wins may not be worth the extra cost.
Mei Ling gets her first win in month 5 and her second in month 15. Under the avalanche, her first debt would not be cleared until month 21. Because she has stopped twice before, the snowball's early wins may make it cheaper in practice for her. A plan she finishes can cost less than a plan that is cheaper on paper but abandoned. Suppose she started the avalanche and gave up in month eight. Her debts would stay at their full rates, often with new spending added on top, and that would cost far more than the snowball's extra interest of about S$1,122.
The avalanche suits you if you are confident you will stick with a plan without quick results, and your debts have a rate gap large enough for the savings to matter. The snowball suits you if you have started and stopped before, if a long list of separate bills is wearing you down, or if your debts have fairly similar rates, which keeps the extra interest small.
The interest gap between the two methods depends on your own debts. If your smallest balance also has a high rate, the two methods may give the same order and cost the same. The gap is widest when the smallest balance has the lowest rate and the largest balance has the highest, as in Mei Ling's case. Lesson 6.4, "Run avalanche and snowball on a worked example", has you measure that gap for your own list before you choose.
A mixed approach is also acceptable. You could clear one very small debt first for the win, then switch to the avalanche for the rest. Whichever you pick, three rules shared by both methods matter most: never miss a minimum, never split your extra money across every debt, and roll each cleared payment into the next debt.
Take the page from lesson 6.1 again. This time sort it by balance, smallest at the top. The order from top to bottom is the order you would pay your debts under the snowball method, and it is worth seeing beside your avalanche order from lesson 6.2.
Sort your debts by balance, smallest first, and write down the order you would pay them off under the snowball method.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).