What Is the Debt Snowball?
When you're in debt, you'll do just about anything you can to pay down your loans and get your financial life back on track. But, where do you start?
It can be an overwhelming and scary process to gather your financial statements and tally your debt totals. There are effective debt reduction tools that can help you get an accurate financial picture, but what's the next step after you've faced the facts?
It's time to create a game plan. There are multiple strategies and ideas out there, but one of the most popular is called The Debt Snowball method.
How the Debt Snowball Works
The Debt Snowball is a debt reduction tactic where you start paying off the debt with the lowest balance first. You simply tally up the balances on your loan accounts, and organize them from the highest debts to the lowest.
Once you've done this, you add up the minimum balances of all your accounts and commit to paying at the minimum amount due. Whatever money you have leftover, after paying your bills and minimum debt balances, will be thrown — with a vengeance — at the debt with the lowest balance.
After you've paid off this balance in full, you then roll over your total loan payments together and attack the next debt on the list. This will include all your minimum balances plus the extra payments you've been making towards the first debt.
The Debt Snowball continues to get bigger as you pay down more debts, and roll your payments over to the next balance, until you are completely debt free.
Basic Steps of the Debt Snowball
Now that your game plan is to pay off your debt and loan accounts using the Debt Snowball method, here are the basic steps:
- List all your debts from the highest balance to the lowest
- Pay the minimum due for each account
- Cut your expenses, or earn extra money, and throw any extra funds towards the debt with the smallest balance
- Once this account is paid in full, add the old minimum payments, plus any extra you put towards the first debt, and apply this new sum to the second-lowest debt on the list
- Rinse and repeat until all the debts are paid
One of the main benefits to this strategy is more psychological than anything else. You'll be able to knock out some quick wins, since you're tackling the smallest account first. It should only take a few months (or even weeks) to pay down this balance, giving you that snowball momentum you need to continue forward with the debt paying process.
What You Should Know About This Method
There are few important things to note before choosing the Debt Snowball method. While it's one of the most popular tactics for paying off debt, it may not be the best one for your situation. Another method for paying off debt is The Debt Avalanche, in which you pay off the account with the highest interest rate first. We tend to recommend the Debt Avalanche as the best debt payoff method. However, finances are not a one-size-fits-all kind of thing, so take a look at both options and decide which is best for you before getting started. Here are tips to keep in mind if you select the Debt Snowball method:
Give lenders a heads up. You may want to contact your lender and tell them to put any extra payments toward the principal balance of the loan. Some financial institutions (like auto or mortgage lenders) will apply extra money towards the next payment, essentially splitting the payment between the interest and principal. You want all the funds to go towards the principal so you save money on interest and get out of debt faster.
Go for the highest interest rate. You can always modify the Debt Snowball plan. For example, in the event you have multiple debts that have a similar balance due, you can choose the debt with the higher interest rate to be paid off first. You'll be saving loads of money by negating some of the compound interest that could be added to your account in the future. And you'll still basically be following the Debt Snowball approach.
Don't risk your retirement. The Debt Snowball is very effective for a short period of time (and is the method I personally used while becoming debt free), but it should be carefully implemented. During the debt payoff process, many people will choose to halt their monthly savings or retirement contributions in order to get out of debt faster. This can be a smart move — if you don't do it for too long. You don't want to sacrifice your retirement, and therefore your quality of life, in order to pay off debt too quickly.
Ultimately, what matters is that you make the effort to pay off that debt and stay motivated even if it takes a long time. You can use our resource centers and our debt repayment tool to help you accomplish your goal!
Would you consider the Debt Snowball to pay off your debts? Why or why not?
Carrie, a guest blogger for ReadyForZero. Carrie Smith is the writer and editor behind Careful Cents, a blog aimed to help solopreneurs and full-time freelancers make valuable connections and grow their businesses.