Finance explained: What is the stack method? What is the snowball method?
All of us have some kind of debt to pay back. It could be a mortgage, personal loan debt, car loan debt, student debt or credit card debt. According to the Australian Bureau of Statistics, 70% of all Australians have some kind of debt they are paying off. There are two main ways of paying these debts off quickly that you may have heard about. They are known as the “Stack” method and the “Snowball” method. But what are they? How do they work? Join Smallloans.com.au for a walk through these debt reduction methods in this edition of Finance Explained.
Before you start
Before you commit yourself to using either of these methods you have to stop creating new debts, if you can avoid them. You may also want to think about creating and sticking to a strict budget. Sometimes the unexpected happens and you’ll need a small cash loan or a payday loan to help you out. But if you don’t need that new TV or new car right at the minute, wait until your debts are cleared or are significantly paid off before creating any new debts.
Method #1: The Stack Method
The Stack Method is a way of paying off your debts in order of highest interest rate to lowest interest rate. Here is what you do: you get a list of all your debts owing right now. You rank them from the highest interest rate to the lowest interest rate. This might look like:
1. Credit card – $4,000 at 19% p.a – highest interest rate
2. Personal loan – $6,000 at 10% p.a. – 2nd highest interest rate
3. Car loan – $2,000 at 8% p.a. – lowest interest rate
The stack method advises you to pay the minimum monthly amount on your Car loan and Personal loan, directing any extra money to paying off your Credit card. The idea is that the less time that passes paying high interest rates, the better. Even though the personal loan in this example has a higher balance, you are still paying far less in interest.
Method #2: The Snowball Method
The Snowball Method kind of flips the Stack method on its head a bit, as this method directs people to pay off the lowest balance first, regardless of interest rate. So using the example above, we’d now rank these:
1. Car loan – $2,000 at 8% p.a. – lowest balance
2. Credit card – $4,000 at 19% p.a. – 2nd lowest balance
3. Personal loan – $6,000 at 10% p.a. – highest balance
Just like the Stack method, the Snowball method directs you to pay all your minimum repayments every time, on time. But in this case, you would funnel all your additional money after bills and necessities to the Car loan. The downside is that you will eventually pay more in interest than the Stack method, but this method inspires you to keep chipping away, as paying off each individual loan or debt comes quicker.
Which is best?
There’s no real answer to this; it depends on your individual preference. If you feel you might not stay on track, the Snowball method is best as it gives you more satisfaction and a sense that you’re making real progress. If you tend to be more logical about things, the Stack method is the best. That’s because paying off higher interest rate debts first will save you more money in interest repayments. These methods are simply guides to help you out of debt sooner. Whether you use Stack or Snowball, you will be well on your way to reducing your debt, perhaps down to zero.