How Best to Escape Debt? The Snowball Method, the Avalanche Method, or Bankruptcy?

 

Before filing bankruptcy, many Michigan consumers attempt alternative methods of debt repayment. For some, these attempts are successful. A Chapter 7 or Chapter 13 bankruptcy filing is avoided, and all is well.

For others, debt repayment techniques such as the “snowball” method or the “avalanche” method are long slogs through increasing interest rate accrual and balances owed.

Chapter 7 and Chapter 13 bankruptcy, in these cases, are quicker, easier, cheaper, and far more predictable means of escaping debt.

 

Which Is the Better Path for You?

 

This Article will attempt to explain the alternative debt repayment and discharge paths available to Metro Detroit residents—and to provide a means of assessing which is right for you.

First, however, let’s clarify one thing: while many websites discussing these topics will express the choice between them as a matter of “personal preference,” this is not accurate.

What does “right for you” actually mean?

It means that you need to choose the debt escape method that actually works. That is, the one that saves you money.

This Article will function on nuts and bolts. Cost-effectiveness. Legal enforceability. Time.

“Personal preference” is a meaningless concept. No one prefers to file bankruptcy. But they do file bankruptcy—because it actually works.

That said, let’s explore these methods for dealing with overwhelming debt.

 

The Snowball Method of Debt Repayment

 

Neither the Snowball Method nor the Avalanche Method make debt vanish. That is the first difference between these options of which you should be aware.

The Snowball and Avalanche Methods are techniques for debt repayment. In full. Including all interest and late-fee accrual, as applicable.

The Snowball Method is touted by a variety of non-lawyer (and often non-credentialed) financial “gurus” who may have some financial expertise. Or who may simply be ex-waitresses with some social media savvy.

Will it work for you? It really depends upon your resources, your personal obligations, and your patience.

Here’s how it works, below.

The Snowball Method requires that you concentrate your available funds on one debt at a time.

 

1. You start by paying the debt with the smallest debt first.
2. Then, you throw as much money as you have available at that debt.
3. Meanwhile, you pay only required minimum payment amounts to your other debts.
4. Once that first debt is fully repaid, you move on to the next.
5. And then the next.
6. And so on, until all of your debts are repaid, leaving you free to buy that Scottish castle you always wanted.

 

The Avalanche Method of Debt Repayment

 

The Avalanche Method is similar to the Snowball Method but with a different “debt priority” focus.

In the Avalanche Method, you concentrate your payments upon the debt owed with the highest interest rate.

In this way, the Avalanche Method is a tad more scientific than the Snowball Method. The motivating factor of the Snowball Method is the elation and joy that you feel when you successfully pay off that first debt with the smallest balance.

The Avalanche Method aims at reducing the total monthly amount that you are obligated to pay as efficiently as possible. Even if that’s just by a dollar or two each month.

As with the Snowball Method, you would make minimum monthly payments toward the other debts while repaying the highest APR line-item first.

 

What’s Wrong with the Snowball or Avalanche Methods?

 

Both of these debt repayment methods are nice ideas. One of them may work for you. Paying off all of your debt in full, without missing any monthly installment payments is certainly the right way to keep a credit score intact.

However, it’s important to remember that a credit score is not a barometer of moral worth. It is simply a number, the result of an artificial formula developed by the Fair Isaac Corporation used to determine whether or not you should be lent money and, if so, at what interest-rate.

In other words, if you’re not currently trying to finance a new mortgage or car loan, it’s completely meaningless.

If you believe that your FICO score “says something” about your moral qualities or other such qualities, think again. You’ve been sold a line of propaganda by Fair Isaac and other financial lending institutions.

The real questions regarding the Snowball and Avalanche Methods are:

 

• Whether you can successfully follow the plan given life’s ups and downs;
• How long the plan will take to complete; and
• How much you will pay in terms of interest and other fees while you’re executing it.

 

Let’s not forget that required minimum payments to the “other” debts will often result in higher balances as minimum monthly payments will often not keep pace with ongoing interest charges.

 

Bankruptcy: A Shortcut to Freedom from Debt

 

Again, the Snowball and Avalanche Methods are debt repayment techniques. They are not debt escape techniques.

They only work if you have the income necessary to execute those methods. What if you are underpaid, underemployed, or unemployed? What if your debt is the result of a significant one-time medical emergency for which you could not possibly have budgeted? How about the death of a spouse? A parent? A criminal legal matter?

The Avalanche and Snowball Methods are cute ways to repay debt you’ve incurred within the confines of your specific lifestyle and your specific budget.

But consumer debt, such as a credit card balance, is not the only source of indebtedness that life can bring. The examples above are just a few that Michigan bankruptcy attorneys commonly encounter among their clients.

It may be that you’ve outspent your income and that the Avalanche and Snowball Methods are unaffordable for you on your income just because you went a little crazy. More commonly, this will be the case when the debt slammed down on your life like a meteor from space, without any ability to foresee or budget for it.

Medical debt can be immense. Hospitals, ambulance services, and doctors are ruthless and relentless creditors. Fitting their demands into the too-neat structure of a Snowball or Avalanche repayment scheme will often be simply impossible.

What is needed in this case is not a debt repayment method but a true debt escape method.

This is what Chapter 7 and Chapter 13 bankruptcy provide.

 

The Advantages of Debt Escape through Bankruptcy

 

So why is bankruptcy often a better option for Detroit-area consumers? The main difference between bankruptcy and the other options discussed here is that bankruptcy does not require that you repay the debt in full.

Unless you hold one of the few types of debt not dischargeable in bankruptcy (such as, for example, child support obligations), a Chapter 7 bankruptcy in particular will enable you to fully discharge and escape your debt without paying a dime.

There are exceptions to this “just walk away” possibility, naturally. Particular exceptions of note are described below in the next section.

In a Chapter 13 bankruptcy, you do not discharge debt entirely. Instead, you repay what you can afford to pay through a 3-5-year court-supervised and -ordered payment plan. Whatever debt is not repaid through that Chapter 13 plan is then totally discharged just as in a Chapter 7 bankruptcy.

If the prospect of a 5-year Chapter 13 bankruptcy process seems daunting, consider whether the Snowball or Avalanche Methods will free you from your particular debt in any shorter timeframe. If you have more than 2 or 3 credit cards or other forms of debt, it is likely that those non-bankruptcy methods will not provide quicker escapes from your debt.

A Chapter 7 bankruptcy process is typically only 4 months long, furthermore.

In either form of bankruptcy, to the extent you repay anything, you pay zero interest, zero late fees, and you are not required to negotiate or communicate directly with your creditors at all (with few exceptions, such as an ongoing mortgage payment).

In bankruptcy, creditors must cease all collections activity as soon as the bankruptcy case is filed as the Automatic Stay goes into effect instantly. Any violation of this injunction will expose them to sanctions upon motion filed by your Michigan bankruptcy attorney.

 

The Disadvantages of Bankruptcy

 

For some, bankruptcy poses some noteworthy disadvantages.

• Credit Score Impact

The most common misgiving revolves, again, around the sacred credit score. Yes, your credit score may take a dip when you file for bankruptcy.

Before panicking, it is important to remember that the FICO score, although its exact math is a trade secret of the Fair Isaac Corporation, is largely premised upon your available credit amounts and your debt-to-income ratio.

When you file for bankruptcy, any open lines of credit you have will nearly always be closed by your lenders. Thus, your available credit will, for a time, be zero. That affects the FICO score adversely.

The presence of the bankruptcy filing on your credit report also, itself, weighs down the score.

But what about that debt-to-income ratio?

This will also be zero once your bankruptcy discharge comes through and wipes out the debt. You’ll have nothing but … income in that ratio.

This is very beneficial to the credit score formula, and is an under-discussed advantage of bankruptcy filing.

In any case, if you’re suffering from unmanageable debt and have already begun missing monthly debt payments, your credit score is already shot. Bankruptcy can only help at this point.

 

• Income Eligibility Requirements

 

To file a Chapter 7 bankruptcy in Michigan, you must pass the so-called Means Test. Your household income must be under the median average in Michigan for a household of your size.

 

More thorough discussions of the workings of the Means Test and other income-based eligibility criteria can be found elsewhere on our website and blog.

However, “failing” the Means Test does not mean that you are ineligible for bankruptcy. It only means that you must file a Chapter 13 bankruptcy instead.

Chapter 13 bankruptcy is, for the reasons discussed above, still a better option for many than the Avalanche and Snowball Methods.

In any case, avoid all purported online Means Test calculators.

Proper calculation of a bankruptcy Means Test should be performed by an experienced bankruptcy lawyer only. It is not simple math; much local bankruptcy court law and specific Bankruptcy Court Rules feed into the ultimate results.

 

• Asset Protection Issues

 

A minority of those filing for Chapter 7 or Chapter 13 bankruptcy in Metro Detroit will own high-value assets or property. Ownership of valuable property can affect the usefulness of the bankruptcy process relative to the Snowball or Avalanche Methods.

In a Chapter 7 bankruptcy process, high-value or luxury assets can be seized and sold off to provide some repayment to your creditors.

No assets, however, are ever seized or liquidated in a Chapter 13 bankruptcy. Your property is as safe in Chapter 13 as it would be in the Snowball or Avalanche Methods.

In fact, it may be more safe, given the failure rate of debt repayment schemes and their ongoing exposure to creditor collection activity, including lawsuits and asset-seizure. In Chapter 13, your creditors can do no such thing.

Nevertheless, ownership of high-value assets in Chapter 13 can be costly. While the property will never be seized from you, it can cause your Chapter 13 Plan payment to be higher.

The mechanics of this issue are discussed in detail elsewhere on this site and in our bankruptcy blog.

 

The Snowball and Avalanche Methods vs. Bankruptcy: The Bottom Line

 

The bottom line is that the decision to escape debt through the Snowball Method, the Avalanche Method, Chapter 7 or Chapter 13 bankruptcy, or some other means is highly specific to your circumstances.

It is not, however, a matter of “personal preference.” Or, at any rate, it shouldn’t be. The decision to choose one avenue over the others should be a coldly calculated, “scientific” decision.

That is, the decision should be the result of careful math and cost-benefit analysis performed with the assistance of a licensed expert and not a website or self-help book authored by a former waitress turned financial “guru.”

Attorney Walter Metzen is a Board Certified Bankruptcy Expert who has successfully assisted thousands of Metro Detroit Chapter 7 and Chapter 13 clients for over 30 years.

If you are considering bankruptcy but aren’t sure whether it is the right path for you, contact us to schedule a free, no-obligation consultation.