The Debt Snowball Method
Do you want to build a snowman? We know that to build a snowman you have to create a snowball by packing the snow together. Once that task is completed, you have to continue adding snow to help it grow, eventually creating a big enough ball to roll around on the ground. As you know, the more you roll a snowball around, the larger the snowball will become. This is not much different when it comes to collecting debt because as we grow into our lives, careers, and ultimately family, we will continue to accrue debt. So, what does this have to do with finances? Dave Ramsey, a financial businessman, has helped create tools and steps to becoming debt-free. One method he has helped to popularize is the debt snowball method that helps provide steps on becoming debt-free and saving money while strengthening money management skills over time.
WHAT IS THE DEBT SNOWBALL METHOD?
The debt snowball is a debt reduction strategy where you focus on paying off your debt from the smallest to the largest, eliminating the remaining balances. This method works by building momentum as you continue to pay down and eventually pay off your debt. When the smallest debt is paid, you will take the payment you were making on that debt and apply it to your next debt account, basically building, "snowballing", your repayment of the next smallest debt. To begin the process you will start with a few steps.
List debt from smallest to largest regardless of interest rate.
Make minimum payments on everything except the smallest.
Pay as much as you can on the smallest debt.
Once the smallest debt is paid put the extra money towards the next smallest debt.
Repeat until each debt is paid in full.
Why start with the smallest debt first? In most instances, your largest debt will likely have a higher interest rate which means it will take much longer to eliminate that debt or see the difference in the balance which can be discouraging. Beginning with your smallest debt and working your way to the second smallest and so on will pay off the debt much sooner, motivating you to continue on the path to becoming debt-free.
It may be difficult to understand how the debt snowball method works, but taking control of your finances is the first and most important step and the debt snowball method not only helps you financially, but it helps change financial habits while establishing new ones. Once you begin to make these changes, you are most likely to continue these behaviors because of the positive results.
ABOUT INTEREST RATES
You may wonder why you are told to disregard interest rates, but it is a practical step towards becoming debt-free. If you were to begin paying a large debt such as your car, mortgage, or student loan first you may see little change in the overall debt for some time. Changes you do see will be encouraging at first, but at one point you will stop paying extra on that debt. Why? Simply put, you feel you're not winning because of the length of time it is taking to pay off this debt which causes you to lose the desire to continue, plus you will still have all your smaller debts to pay. Feeling discouraged many people will give up and revert to their previous habits.
This is why starting with the smallest debt is important. You will see progress much quicker, which gives you the confidence to continue. Once you have paid this smaller debt off, you will move to the next item on your debt list and continue. This may sound confusing but once you look at the process it can be quite simple to follow.
EXAMPLE:
$500 medical bill—$50 payment
$2,500 credit card debt—$63 payment
$7,000 car loan—$135 payment
$10,000 student loan—$96 payment
When we factor the debt snowball method into approaching this debt, you will pay the minimum debt on all accounts EXCEPT the $500 medical bill. At this time, it will be a good idea to look at your finances as a whole and find out how much you can afford to put towards your medical debt on top of the minimum payment. If this is $50 or $300 you will add this to your minimum payment. For example, If you can put an extra $200 toward your medical debt, then you will be making a $250 payment. While paying $250 a month, $50 minimum plus an extra $200, towards the debt you will have paid it off within 2 months. Now take the $250 and apply it to the next smallest debt which is your credit card. By using the same formula where you pay $313, $63 minimum payment plus $250 payment, towards your credit card debt, meaning you can have your credit cards paid off in roughly 8 months. Next on the list is your car loan payment, using the formula established you will make a payment of $448, $313 payment plus minimum payment of $135, allowing you to pay off the loan within roughly 16 months. By the time you have reached your student loan payment, you will be able to put $544, $448 plus minimum payment of $96, towards your payment paying off your biggest debt in about 18 months!
POSSIBLE DISADVANTAGES
The debt snowball method may look good on paper however some have pointed out that interest rates also play a significant role in paying off debts. This method eschews interest rates and instead places focus on the principal amount, which can lead to many paying more money towards interest over time. It is important to look over your APRs and loan interest rates to ensure that you don't end up paying more in the long run.
The debt snowball method is just one method of debt repayment that may or may not work for your financial situation. There are other options to aid you in becoming debt-free and the best option is to comb through finances, evaluate your debt, research debt repayment strategies, and begin planning. If you are unsure it is always a good idea to reach out to a professional such as a CPA that can guide you through the process.