Sometimes, you may find yourself having more than one loan to repay. Life happens, and circumstances may force you to take out multiple loans from quick money lenders.
This situation can trap you in debt if you’re not careful. If you’re wondering how you can escape debt, you have two ways to pay them down – the snowball method and the avalanche method. Here is the difference between the two.
Snowball method
In the snowball method, you will prioritise paying off the smallest loan first, then move up to the second smallest loan until you pay off the biggest one. While paying off one loan, you will only pay the minimum amount for all the others.
Here is how that will work. Let’s say you have five loans to pay off:
| Loan | Principal amount | Interest rate | Minimum payment |
| Loan 1 | $1500 | 10% | $100 |
| Loan 2 | $1000 | 15% | $75 |
| Loan 3 | $2000 | 5% | $120 |
| Loan 4 | $500 | 25% | $20 |
| Loan 5 | $100 | 20% | $10 |
Loan 5 has the smallest principal amount, so you need to pay down this loan first. Initially, make the minimum payments for the four loans. Then, pay off Loan 5 in full if you can afford it. If not, repay as much of the principal amount as your money allows.
Once Loan 5 is fully repaid, you can move on to paying down Loan 4. Next comes Loan 2, then Loan 1, and finally Loan 3.
Avalanche method
The avalanche method, on the other hand, aims to pay off the loan with the highest interest rate first. This is not necessarily the loan with the highest principal amount.
In the example above, Loan 4 has the highest interest rate of the five loans, at 25%, but its principal amount is only $500. Following the avalanche method, you need to pay down this loan first while repaying the minimum amounts for all the other loans.
Once Loan 4 has been fully repaid, you will move on to paying down Loan 5, then Loan 2, then Loan 1, and finally, Loan 3.
Which one is better?
Looking at the numbers and mathematics alone, the avalanche method is the better choice. You will end up saving a significant amount of money in interest payments. Though it may take a longer time to fully pay off a loan with a really high interest rate, this method will prevent even more interest from piling up.
But the snowball method also has its merits. While it may not be the most mathematically sound choice, studies have shown that more people are able to get out of debt using this method.
By paying off the loan with the lowest principal first, you can get a quick win, which motivates you to pay down your remaining debts. As you pay off bigger loans, your motivation grows further.
Be aware, though, that the snowball method often incurs more interest payments than the avalanche method. So if you have the discipline for a longer-term victory over debt, go for the avalanche method. But if you always need motivation to pay off your debts, the snowball method is the way to go.