The debt snowball method, popularized by Dave Ramsey, involves paying off the lowest balance debt first, then rolling that monthly payment into the next lowest balance and continuing the process until all debts are paid off. The debt avalanche method involves paying off the highest interest rate debt first, after adjusting for whether the interest can be deducted, and then moving on to the next highest interest rate debt. The debt snowball method is believed to be easier to follow, as paying of a low balance debt provides huge emotional satisfaction, thereby encouraging people to work harder to pay off their debt. The debt avalanche method is mathematically correct, and can save thousands of dollars in interest compared to the debt snowball method.

Researchers at Harvard have now weighed in on the debate, after studying 6,000 HelloWallet accounts and conducting three experiments. They found that people who focus on one debt pay down their debt more quickly than people who spread their excess principal payments across multiple debts. They also found that people are more motivated by seeing the percentage decrease in their debt than seeing an amount decrease. As a result, the debt snowball method is effective in encouraging people to work harder to pay down their debt. Surprisingly, though, debt consolidation may be counterproductive because it takes away those emotional benefits of paying down low balance debts and instead creates one seemingly insurmountable debt.

That the debt snowball method is more effective in encouraging people to pay down debt is not surprising. I wish the study had stated the degree or percentage of improvement created by the debt snowball method. A 2-3% increase in debt paid off may not justify paying off debts in the wrong order. On the other hand, a 10% increase in debt paid off might mean that almost everyone should be using the debt snowball method. As it stands now, I do not think my advice has changed: if the interest rate disparity is significant, then focus on the highest interest rate debt.  If the interest rate disparity is not significant, and you need the emotional benefits of the debt snowball method to stay motivated, then use that method. If you are disciplined and able to stick to your debt repayment strategy, then you are better off in the long run using the debt avalanche method.

-Richard

Disclaimer