Latest posts by Kumiko Ehrmantraut (see all)
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The one thing we look for when paying off debt is progress. It always feels like the debt load can't shrink fast enough and the want to be debt free only creates more frustration. So how do you begin to pay down debt while still keeping your sanity and motivation?
If you are paying off several debts, a system that keeps you motivated with proof of progress can help keep you on track.
The debt snowball method is designed to be this type of debt repayment strategy. One of the greatest advantages is the psychological boost it gives people. Scott Rick, Ph.D. stated in an article on Psychology Today that the pleasure associated with wiping out debt might cause people to choose to pay off a small debt instead of buying something new. Though there are many psychological benefits to using the debt snowball method, there is also one big disadvantage.
It's important to know that if you decide to conquer your debt using this strategy, you will ultimately leave money on the table. Paying off debt by amount owed and not by how much interest you will pay over the long run will ultimately lead to you paying more interest over time.
It is very different from the debt avalanche method, which gives you a plan to pay off the high-interest debt first.
With the debt snowball method, you pay off debt in order from smallest to largest. One of the biggest supporters of this method is author and radio personality, Dave Ramsey. Ultimately, the method you choose to use while tackling your debt needs to be based on how well you know yourself. If you are the type of person who wants to celebrate short-term victories to inspire you to keep going, then you are the perfect candidate for the debt snowball method. If you are more analytical and saving money along the way is your goal, then the avalanche method might be a better choice.
BEFORE YOU GET STARTED
To decide how much money you have to use for debt repayments, you first have to calculate your monthly expenses. Creating a budget will allow you to see how much money you have left over to eliminate debt.
If you are working with limited income and a tight budget, I highly suggest that you start using the Cash Envelope Method for budgeting. I have written a detailed guide on how to create a budget using this method that you can read HERE.
Any extra income that you come across outside of your normal budget should be used to pay off your priority debt. This is sometimes called “debt snowflakes” and can help speed up your debt payment efforts.
HOW TO USE THE DEBT SNOWBALL METHOD
STEP #1: LIST YOUR DEBTS BY BALANCE
The first step in using the debt snowball method is arranging your debt from smallest balance to largest. Since you are only focusing on how much you owe, there is no need to record the interest rate for each debt.
STEP #2: COVER YOUR MINIMUM PAYMENTS
When creating your budget, it's important to budget enough to cover your minimum payments for each debt owed. Add up all of your minimum payments and then figure out how much extra money you have by using your budget. This can be found by subtracting your income from your expenses. If you have a positive number, that is the amount of extra money you have to begin to get rid of your debt.
If you end up with a negative number after you subtract your income from expenses, look for areas in your budget where you can cut back. For example, get rid of cable and get services such as Sling TV, Philo, Netflix or Hulu. Find ways to save on gas by taking advantage of public transportation or carpool with a spouse. Look for areas in your grocery budget where you can save money by using apps such as Ibotta.
STEP #3: START MAKING PAYMENTS
You still need to pay your minimum payments on each debt, but any money left over in your budget needs to be thrown at the smallest balance debt first. For people like me, who are obsessed with numbers and math, this can drive you absolutely crazy. With the debt snowball method, it doesn't matter if your highest-interest debt is the largest. Your smallest balance might be an interest-free loan, but using this method, it's the first to be repaid. If this really bugs you, then using the avalanche method is the best option.
Once your smallest balance debt is repaid, reorder your debts and start the process over. When you are ready to move on to your second priority debt, take the minimum payment and the extra funds you were using to pay off priority debt #1 and apply it to priority debt #2.
HOW IT LOOKS IN REAL LIFE
For example, let’s assume you have three debts you are trying to pay off.
- $1,000 hospital bill (annual interest rate = 0%)
- $5,000 credit card (annual interest rate = 22.9%)
- $4,000 credit card debt (annual interest rate = 15.9%)
By using the debt snowball method, you would pay off the $1,000 hospital bill first. Yep, that's right. You would pay off the debt with 0% interest first before the debts that are accruing interest.
To make the example simple, let's assume the minimum payment for each debt is $50. If you have a total of $300 every month that you can use to pay down debt, $150 of that $300 will go towards covering the minimum payments, and the $150 that's leftover would be applied towards paying off debt.
With the debt snowball method, that extra $150 would go towards the smallest balance first, which in this example is the hospital bill. That means you would be paying a total of $200 ($150 extra funds + $50 minimum payment) towards the hospital bill until it was completely paid off.
Once the hospital bill is paid off, the extra payment would go towards the $4,000 credit card because it has the second lowest balance. That means you would be paying a total of $250 ($150 extra funds + $50 that you were paying towards the minimum payment from the hospital bill + $50 minimum payment from the $4,000 credit card) towards the $4000 credit card until it was completely paid off.
Finally, once the $4000 credit card is paid off, you would then put all $300 towards the last remaining debt, which in this example is the $5,000 credit card.
IS THE DEBT SNOWBALL METHOD FOR YOU?
Abandoning rationale thinking in favor of seeing progress when you get rid of debt has the potential to cost you money. Is the sense of achievement worth it? That's the question you have to ask yourself when deciding on a method to pay off debt. How do you define success? Is it getting out of debt quickly or is it paying the least in interest?
A study conducted by Kellogg School researchers found that people with large credit card balances are more likely to pay down their entire debt if they focus first on paying off the cards with the smallest balance – even if that approach doesn't make the best economic sense.
Even if there are studies and evidence out there that support that quick wins fuel motivation, it's important to base your decision on knowing all of your options and the disadvantage and benefits of each.
MagnifyMoney has an awesome calculator that shows you the breakdown of each method. Just enter your different debts and how much you can afford to pay each month to get rid of debt. Once you have entered in this information, it will show you how much you will pay back for each method and how long it will take you to pay it off. It's a great free resource that I recommend using before making a decision on what method you are going to use.
- Resource: Vertex42 Debt Reduction Calculator
Is seeing progress quickly more important that saving money on interest? Let me know your thoughts in the comments below!
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