Tuesday, 06 October 2020 15:53

 

Avalanching, snowballing or consolidating – choose what works for you

Which is best? Avalanching, snowballing or consolidating? It depends - but is worth thinking about because your choice could affect your financial future.

Nozizwe Fakude, head of consumer insights at financial services provider, DirectAxis, says the terms don’t describe inexpert skiers but rather strategies for repaying debt. There are pros and cons to each so being honest about what motivates you is important when considering an option.

With the avalanche strategy, you focus on paying off more on the debts with the highest interest rates. Usually, these will be personal loans, retail store cards and credit cards.

Typically, it’s an approach that works best for people who are logical, methodical and are motivated more by facts and figures than constant encouragement.

This is how it works:

  1. List all your debts in order of the interest rates on each, starting with the highest.
  2. Keep making the minimum payments on all your debts but pay a little more on the debt with the highest interest rate.
  3. Once you’ve paid off that debt, cross it off the list. Add the amount you were repaying on that debt to the repayments on the one with the next highest interest. And so on.

The avalanche strategy is effective because it focuses on interest.

Loan repayments usually include both interest charges and repaying the balance of the loan. On high-interest rate loans, most of your repayment may be covering the interest but only a small proportion is reducing the balance. By paying more than the minimum instalment on these loans you reduce the balance faster and so save on interest.

If the debt avalanche strategy saves money on interest and can also reduce the time it takes to repay the loan, then why should anyone need another strategy?

“The avalanche approach requires discipline and takes time. Sacrificing to make the extra payments if you don’t see quick progress can be frustrating. It’s been said that the way people manage their finances is often 20% knowledge and 80% behaviour. Understanding something doesn’t necessarily mean you act on it,” says Nozizwe.

The snowball strategy is all about building motivation, so you stick to your debt repayment plan.

The way it works is:

  1. List all your debts starting with the smallest.
  2. Keep making the minimum payments on all your debts but pay a bit more on the smallest debt.
  3. When you’ve paid off the smallest debt cross it off the list and add the amount you were paying to the next one on your list.

The concept is that paying off the smaller debts provides a series of victories which will encourage you to stick to the plan until you ultimately tackle the larger loans.

“Although, in the long run, it may cost you a bit more in interest that’s better than getting disillusioned because you aren’t seeing results and giving up,” says Nozizwe.

Debt consolidation involves taking out one longer-term loan in order to pay off a number of smaller debts such as personal loans, credit or store cards.

Consolidation loans usually have fixed interest rates so it’s easier to budget and manage your financial affairs. Having only one loan also means you’re less likely to miss repayments.

Consolidating debt may also save you some money on services fees and credit life cover costs. Depending on how the loan is structured it could also improve your cash flow by requiring smaller payments over a longer period. You do need to bear in mind though that you’ll be paying interest over a longer term too.

“Something that’s common to all these approaches is that it is critical to make the minimum payments on what you owe. If you don’t you may need to pay penalties and missed payments will negatively affect your credit score.”