What Is The Debt Snowball Method And How Does It Work?
Do you want to pay off debt and become debt free but you lose motivation quickly as it does not seem like you are getting any closer to the finish line? The debt snowball method may be the key for eliminating your debt. The idea of this method is to start with a small snowball and build it up creating a large snowball by the end having no debt left. You will do this by tackling your smallest debt first, then your next smallest debt and continuing in order, finally paying off your largest debt and reaching the finish line. Before starting your debt snowball it is a good idea to call the companies which you have debt with to determine if they can offer you a lower interest rate. To start the snowball going, any extra that you would normally spread over all the debts, you now put it all on your smallest debt while you also continue paying the minimum payments on the rest of them debts. It is just a small reshuffle of funds. If you have anything over and above the normal amount you would pay then you add it to the one you are focused on paying off (the first one, in this scenario, the smallest) Once you reach the milestone of finishing paying off the first debt now you will then take the money (don’t put it in your pocket yet-remember debt freedom is the goal) you were using on that debt and add it to your current payment of your next lowest debt and so on. You will save a lot of interest dollars paying your debts off this way. Mortgages are not included in the same way for this, as their interest is not compounded the same way. We are talking about credit cards and loans for these examples.
Debt Snowball Example
Here is an example of the debt snowball plan.For this scenario let’s say you have $63,000 outstanding owing to the following lenders:
- Personal Loan from a Bank – $5,000, 6% Interest Rate, minimum payment of $110.
- Credit Card Balances – $10,000, 21% Interest Rate, minimum payment of $210.
- Car Loan – $13,000, 9% Interest Rate, minimum payment of $281.
- Student Loans – $35,000, 7% Interest Rate, minimum payment of $290
You will now start with your smallest debt which is the bank loan at $5,000. You will put the maximum payment you can afford towards this while paying the minimum amount on all your other debts. If you can pay an extra $90 making your payment $200 you will pay your bank loan off in 18 months and only would accumulate $231.03 in interest. After this debt is paid off, you take the entire 200 and add it to the next debt, watch it be paid off in super speed.
Debt Snowball Method Alternatives
An alternative to the debt snowball method is using the avalanche method to eliminate debt. The debt avalanche focuses on the debt with the highest rates of interest versus starting with smaller debts.
| DEBT SNOWBALL Focuses on your smallest debt first |
DEBT AVALANCHE METHOD Focuses on your high interest debt first |
| Step One – Outline your debts Outline all of your debts from the smallest balance to largest balance. | Step One – Outline your debts Outline all of your debt from highest interest rate to lowest interest rate. |
| Step Two – Determine your payments In this method you will continue making minimum payments on each of your debts while determining how much extra cash you can add to your payment amount for your smallest loan. | Step Two – Determine your payments In this method you will continue making minimum payments on each of your debts while determining how much extra cash you can add to your payment amount for your highest interest debt. |
| Step Three – Continue onto your next smallest debt until you no longer have debt. Once you have paid off your smallest debt. Take that money and add it to the minimum payment of your second smallest debt. Continue this until all your debt is paid. | Step Three – Continue onto your next highest interest debt until you no longer have debt. Once you have paid off your largest interest debt using the debt avalanche method. Take that money and add it to the minimum payment of your second highest interest account. Continue this until all your debt is paid. |
Main Advantage / Disadvantage Of The Snowball Method For Debt
With every plan when getting out of debt there can be advantages and disadvantages which may affect the approach you take.
Advantage: One great advantage of paying off debt with this method is that you will constantly be seeing improvements and victories. Your small debt takes less time to pay off than larger debts so you will eliminate debts in full quicker. You will quickly start to see the light at the end of the tunnel as well as giving yourself a psychological boost which can help encourage you to stay on track.
Disadvantage: Since you start off by paying small debts you may not save as much money on interest rates as your highest loan may have the most interest. Even though you are still paying the minimum amount this loan may grow a bit due to interest payments.
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