How it works and how to use it – Forbes Advisor
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Just as your debt can snowball into larger and larger amounts, it can also be reduced by adopting the snowball of debt repayment method.
The debt snowball method is one of the strategies you can use to reduce and ultimately eliminate your debt. It works by focusing on paying off the smallest amount of debt first, then the next largest amount and so on before gradually reaching the maximum amount of debt. This method, popularized by personal finance personality Dave Ramsey, is about building momentum. The hope is that you will repeatedly get a sense of accomplishment by paying off one debt after another.
How Does The Debt Snowball Method Work?
When you adopt the debt snowball method, you first focus on paying off the smallest amount of debt in a short period of time while making payments on other debts. After the smaller debt is gone, you allocate the money you allocated for that debt to the debt with the next smaller dollar amount. In theory, you stick with this method until all of your debts are cleared.
This method creates a snowball effect, which means that progressive debt repayments build on each other and accelerate. It’s like when a snowball rolls downhill, picks up speed, and accumulates more and more snow. Whether it’s snowfall or debt reduction, this effect is building momentum. And, on the debt side, we hope that this momentum will boost your motivation more and more by providing a series of small victories.
How to snowball your debt
Once you’re ready to commit to the debt snowball method, start with these four steps:
- List all of your outstanding loan and credit card debt.
- Organize the list from smallest unpaid balance to largest unpaid balance.
- Deal with the smallest debt first, regardless of the interest rate. When you do this, be sure to make at least the minimum monthly payments on all of your debts. You should then put all the extra money you get for paying off the debt towards the smaller debt. So if the smaller debt comes with a minimum monthly payment of $ 75 but you found a surplus of $ 75 in your debt reduction budget, then you would couple the two amounts together to make a monthly payment of $ 150 on the smallest debt.
- Keep rolling the snowball. Continue to make a monthly payment above the minimum on the smallest debt until it is zero. Then move on to the next smallest debt. Again, keep making minimum payments on your other debts. But now, allocate the $ 150 you paid on the first debt to the next highest debt, superimposing that amount on the minimum monthly payment.
Debt snowball example
What does the debt snowball method look like when you put it into practice? Here is an example. Suppose you have the following debts, with the following associated Annual Percentage Rates (APRs):
In this example, you would tackle the medical bill of $ 900 first, since that is the smallest dollar amount. You would make the minimum monthly payment of $ 50, plus any additional money you could use to pay off that debt. Let’s say the additional amount available is $ 100. Therefore, you would pay a total of $ 150 each month for the medical bill, while paying the minimums owed on the other three accounts. If you keep these monthly payments, you will erase the medical debt in six months.
Once the medical bill is paid, you will move on to credit card debt, student loan debt, and finally, car loan debt. When you switch to focusing on credit card debt, for example, you make the minimum monthly payment of $ 150 and add the $ 150 you paid for medical debt. Money set aside to pay past debts is continually carried over to remaining debts, resulting in more and more money that you can allocate for debts that are carrying larger and larger amounts.
With the snowball method, minimum monthly payments and interest rates play no role in choosing which debt to focus on initially.
What debt to include in your snowball
In your snowball strategy, you can take medical bills, credit card bills, payday loans, personal loans, home equity loans, car loans, and student loans.
However, it is not recommended to include your primary mortgage. Why? There are two main reasons: Mortgage payments and amounts tend to be high and mortgage interest rates tend to be low.
How the debt snowball method costs money
While the debt snowball method offers a number of advantages, it does come with a big drawback. Since the method focuses on the largest debts rather than the highest interest debts, you could end up paying more in interest costs over time. In other words, in exchange for the momentum you gain, you could pay even more money to borrow money.
For example, an interest rate of 2.99% can be attached to the smallest debt and an interest rate of 17.99% to the largest debt. However, the snowball method focuses on eliminating the smallest debt (2.99%) first, which means that you can earn more and more interest on the smallest debt. important (17.99%) because you only make the minimum monthly payment.
How to speed up your snowball debt
Yes, the debt snowball method rewards you for the continued cutting of your debts. But what if you want to speed up the method? Here are five tips:
- Create a budget. Budgeting gives you a better idea of your financial situation. When you budget, you may be able to find savings that you can apply to your debt snowball strategy. For the best chance of success with the debt snowball method, consider budgeting first.
- Set up an emergency fund. Before embarking on a snowball adventure, it may be a good idea to build up an emergency fund. This can give you a financial cushion for unexpected expenses, such as major auto repairs or a hospital stay.
- Be smart with the extra money. Did you get a bonus at work? Did you receive a large tax refund? Consider applying this extra money to your debt. Any excess cash you encounter can help you pay off your debt faster.
- Sell stuff. If you have a really good TV in the attic or a closet full of unworn and undamaged clothes, consider selling them to raise more money for your snowball strategy.
- Start a side activity. From the Uber driver to the dog walker to the music teacher, income from a part-time gig can complement your debt snowball strategy.
Is The Debt Snowball Right For You?
If you believe that small wins will provide you with the motivation you need to pay off your debt, the Debt Snowball Method might be the perfect solution to eliminating your debt. But if you don’t need instant gratification and are upset with the idea of shelling out hundreds or even thousands of dollars in interest charges over time, then the snowball method of debt may not be your best route to debt reduction.
Snowball alternatives to debt
If the debt snowball method isn’t right for you, other debt reduction strategies exist:
- Debt avalanche method. The debt avalanche takes the opposite approach to the debt snowball: instead of focusing on the lowest debt amount first, the debt avalanche focuses first. on the debt at the highest interest rate. Using our four-account debt snowball example above, the $ 7,500 credit card debt with the 17.99% APR would have priority over the other three debts. Using the avalanche of debt, the next debt to be paid off would be the 5.25% APR student loan –until, presumably, you pay off all your debts. There are pros and cons to both the debt avalanche and the debt snowball.
- Debt snowflake. The debt snowflake is all about putting tiny amounts of money into debt reduction. For example, maybe you picked up a $ 1 ticket in the parking lot of the grocery store or received a $ 5 discount for purchasing a product. This “found” money can be used to reduce your debt.
- Debt consolidation. You may be able to take out a loan to consolidate most or all of your debts into a single monthly payment. This could not only make it easier to pay off your debts, but also lead to lower interest rates overall.
- Debt management. Debt management plans, the best of which are usually offered by nonprofit consumer credit counseling agencies, allow you to make a single monthly payment that covers all of your unsecured debt. This can simplify the payment process and speed up the time it takes to get out of debt.
- Debt settlement. Debt settlement usually involves paying off your debt all at once for less than you owe. You can try to settle the debt on your own or use a third party debt settlement company. While this option may sound appealing, it comes with significant risks. Make sure you know the ins and outs of debt settlement before you embark on this route.
The best debt reduction method for you is the one you will use until you have your debt under control. Because it provides early and visible progress, thereby reinforcing your general belief that it is possible to eliminate your debt, the debt snowball method works well for many people. However, if you have large debts that carry a higher APR, you may want to compare the debt snowball to the debt avalanche, or other methods of debt relief, before continuing.
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