Paying off debt can be challenging, not to mention exhausting. When you’re staring down several loans with varying interest rates and amounts owed, it’s difficult to know where to begin.
Fortunately, getting started—or optimizing your efforts, even after you’ve been paying down debt for awhile—isn’t as hard as it sounds. The first step is to settle on a repayment strategy that’s based not just on your finances, but your personal motivators and goals, too.
Need some help selecting the best method for you? Here are the pros and cons of two repayment strategies you can use for student loans, credit card balances and other debt—plus one that’s specific to student debt.
This works just as well for credit cards as student loans. To get started, list your loans according to the balance owed, disregarding interest rates. Your goal is to make minimum payments on all loans, while funneling extra cash to the lowest balance.
Once you’ve got that paid off, the magic—or snowball effect—begins: Money you’ve put toward the first loan shifts to the second-lowest balance. When you’ve zeroed out that loan, apply the money from the first two loans to the next-lowest balance.
Pros: Research shows that small wins—in this case, quickly knocking out smaller loans—can increase your motivation and endurance to keep racing toward the finish line. It can also simplify your finances: As you pay off each loan, you’ll have one less bill to worry about each month, says Certified Financial Planner Gary Silverman, founder of Personal Money Planning in Wichita Falls, Texas.
Cons: From a pure-numbers standpoint, the snowball method isn’t as efficient as the avalanche method (below) because your lowest balances aren’t necessarily tied to the lowest interest rates. That means you could be paying more over time by not hacking away at the highest-interest debt first.
Who it works best for: If you’re overwhelmed and experiencing debt fatigue, this method is likely to give you a mental boost and can motivate you to pay off smaller balances faster, says Kristen Euretig, a Certified Financial Planner and founder of Brooklyn Plans.
In this repayment strategy, most often recommended by financial experts, interest rates take priority. List balances from the highest interest rate to lowest, disregarding all other factors. Your goal is to make minimum payments on all of them, while funneling extra cash to the debt with the highest rate. Once you’ve paid that off, extra money shifts to the one with the second-highest interest rate, and so on.
Pros: By paying off the highest-interest balances first, you save yourself more money in the long run. The avalanche method helps you get out of debt faster too: Since high rates increase your balance, and paying them off means you’re saving more, this indirectly means you’ll spend less time paying debt.
Cons: If your highest rate debt also happens to have a high balance, you may go quite awhile without the psychological boost that comes with paying a loan in full, which may make it tougher to stay motivated to keep chugging along.
Who it works best for: This plan is perfect for people who want to save as much as possible and don’t need the positive reinforcement that comes from knocking out loans to stay on track. “Just make sure you celebrate little milestones, such as paying off every $1,000 of a $10,000 loan, to keep yourself motivated,” Euretig says.
This method is only for borrowers with federally backed student loans.
Federal loans are special in that, under certain circumstances like job loss, they can be placed into a period of deferment, during which timely payments do not need to be made. Federal student loans come in two flavors: subsidized and unsubsidized. Subsidized loans have unique benefits that unsubsidized loans do not—namely that they do not accrue interest while deferred.
To follow this method, separate your loans into two groups, subsidized and unsubsidized, disregarding both loan balances and interest rates. Make minimum payments on all loans, but prioritize unsubsidized loans, using your choice of the snowball or avalanche method. Once your unsubsidized loans are paid off, focus on the subsidized.
Pros: If you have to defer unsubsidized loans due to a financial emergency, interest will continue to accrue. And if you can’t afford to pay it post-deferment, it may be added to your principal.
Alternatively, paying off unsubsidized loans first means you can rest easy that if you find yourself in a rocky financial situation, your subsidized loans won’t gain interest in deferment and wipe out the progress you’ve made.
Cons: Because this is a hybrid method, you probably won’t fully reap the benefits of the snowball or avalanche method. That is, you won’t necessarily save the most money possible or enjoy the most psychological wins.
Who it works best for: This plan values stability over saving as much money or paying off as many loans as possible in the shortest amount of time. If you have federal student loans, find yourself in an unstable company or industry and don’t have extensive emergency savings, this method may be for you.