The Debt “Snowball” Or Debt “Avalanche” May Not Be Best For You
August 20, 2008 – 6:12 am
Much has been written about the “Debt Snowball”, a concept Dave Ramsey has brought into the mainstream media as a solid way to get out of debt. The idea is that you should list your debts from smallest value to largest value, and then pay the minimum on everything but your smallest debt (i.e. debt with the smallest outstanding balance).
Likewise Consumerism Commentary wrote a great post on the Debt Avalanche, which is very similar to the debt snowball. The difference, however, is that your debts should be ordered from lowest interest rate to highest interest rate rather than the “Debt Snowball” way of smallest debt to largest debt.
I’m a fan of Dave Ramsey, but I do concede that his recommendations are designed for mass market appeal and implementation. Therefore his methods may not be optimal for you, but then again if you (and I) were able to make consistently solid decisions with our finances we wouldn’t be so far in debt!
I’m not going to argue the “snowball” verses “avalanche” recommendation. Both are solid and both can work. I am, however, going to raise a different point: perhaps you should consider the risk of each type of debt.
What I mean by this is quite simple: student loan debt and IRS debt are cannot be removed through bankruptcy. As many of us struggle to repay our debts, we often get confused and tend to pay our creditors in the wrong order. Clearly water, food, shelter, and utilities need to be paid first. But after that you might want to consider whether bankruptcy may become a reality for you.
I’m not recommending that anyone file bankruptcy. That decision cannot be made based on general commentary in a blog or even after an individual conversation. What I am saying is you might want to consider paying off the IRS debts first and your student loans second, simply to cover yourself in case you need to file bankruptcy at some point. For example, thousands of families file bankruptcy each year due to medical bills. I would guess that most of these people lacked the medical coverage necessary to insulate themselves from a severe medical situation, but we all know how expensive these bills can be. In the two to three years it may take to get out of debt, could you really absorb a $50,000 or $100,000 hit in unexpected medical bills? My appendicitis would have cost over $50,000 without insurance, and that was a “simple” surgery with less than a 24 hour hospital stay!
Regardless of the amount owed or the interest rate, it might be worth paying the bigger wolves off first before dealing with your other creditors.
Image Credit: Hare Guizer
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8 Responses to “The Debt “Snowball” Or Debt “Avalanche” May Not Be Best For You”
I’ve always thought the debt snowball approach can work well with people that have never established a budget and don’t know where to start. It gives them “quick fix” to see debt repayment in action. I do agree that it may not make the most financial sense, as the highest cc cards might carry bigger rates.
I enjoyed reading this new twist to the debt snowball approach and will include it in this weeks “Posts that motivate and inspire”
By
Scott @ The Passive Dad (Who am I?) on Aug 20, 2008
Student Loan debt can’t be removed by bankrupcy but it CAN be differed under a “hardship” circumstance. If you lose your job or face a sudden and dramatic reduction in income, you can request that the payments on your loan stop for a certain period of time until you can get back on your feet.
Most student loan providers will agree to this as they would rather have you pay the loan back than default entirely.
By
Michael (Who am I?) on Aug 25, 2008
I’ve just started to really take serious, radical steps toward fixing my financial situation. I’m about $45k in debt: credit cards, cars, and student loans.
My plan is to mostly follow the Debt Snowball, because I do think I need the ‘wins’ to motivate me, but I believe I also need to use math as well as psychology. If I have a $4k debt at 5% and a 5k debt at 29%. I’m going to pay down the 29% first, even though it’s the larger balance…
Although, I might consider paying down the lower interest rate first, if it frees up more monthly money. So if that $4k at 5% is $300/mo, but that 29% is only $150/mo, I might consider paying down the 5% first, to free up the $300 which can then be thrown at the 29%.
Either way, I agree with you that there’s not necessarily one right answer. I think Ramsey is just teaching by KISS.
By
Kenny (Who am I?) on Aug 25, 2008
Interesting post - as Dave Ramsey says - you can’t get wrong getting out of debt! If you want to do the snowball, the avalanche, or whatever- just do it! You can’t get wrong getting rid of the debt.
As far as health insurance, if you don’t have it - GET it! My wife, who is normally very health, had a surprise blood clot this year. $250,000 dollars later she’s doing a lot better -but without that coverage we would have been bankrupt! I also had surgery to remove my appendix a few years ago, and without insurance it would have been over 20k. In my opinion health insurance is a must!
By
Pete (Who am I?) on Aug 27, 2008
One more thing about health insurance: since so many health insurance companies have no coverage for “preexisting conditions”, it seems like you ought to get it when you’re younger & healthier, so that they will have to cover any condition you get later! The point is, it’s important to have coverage even if you won’t have one huge medical event, such as a car accident or appendicitis. Ongoing conditions can be super expensive! (E.g. I am young & have rheumatoid arthritis. If I didn’t have insurance, it would be $200-300 every 3 months for the doctor visit, plus $300-400 every 3 months for my blood labs. PLAN AHEAD! : ) )
By
millie (Who am I?) on Sep 3, 2008
Very good point Mille. I have often considered switching to a high deductible plan outside of my employer so I never have to worry about having coverage. It appears from pricing such policies though that my employer must be paying for a large portion of my coverage. It also looked like pregnancy wasn’t covered by a lot of policies, but that may have changed.
By
todd (Who am I?) on Sep 6, 2008