When paying off multiple consumer debts (credit cards, student loans, auto loans, and personal loans), financial planners use one of two structured payoff algorithms. In both methods, you pay the required minimum payment on every account except one "Target Debt", into which you funnel 100% of your extra monthly cash flow:
1. The Debt Avalanche Method (Mathematically Optimal): - Ordering Rule: Rank all debts from Highest APR to Lowest APR, regardless of dollar balance. - Advantage: Minimizes total cumulative interest paid and achieves total debt freedom in the shortest mathematical time. 2. The Debt Snowball Method (Behaviorally Optimal): - Ordering Rule: Rank all debts from Smallest Dollar Balance to Largest Dollar Balance, regardless of interest rate. - Advantage: Eliminates entire individual accounts quickly, freeing up minimum payments and creating behavioral momentum (validated by Harvard Business Review and Northwestern Kellogg consumer psychology studies).