Back in the day as a kid playing in the winter snow, do you remember the fastest way you used to build a snowball?
You likely started out by compacting a small ball of snow and rolling it until it became massive enough to knock the other kids clean off their feet. This is the snowball effect and the debt snowball method works on the same principle.
Imagine a life without debts. Wouldn’t life be sweet?
That is exactly what you stand to achieve by following the debt snowball method of paying off debt.
But how does it work?
How the Debt Snowball Method Works?
The debtor starts by listing all of his/her debts starting with the smallest and ending with the largest. (The mortgage is not included in the list of debts).
The next step involves putting money aside to pay the smallest debt first. This doesn’t mean forgetting about the other debts and the debtor will still be paying the minimum monthly payments on these.
Once the smallest debt is paid off, the debtor now moves on to the next, larger debt in line. This process continues while still paying the minimum payments on the other debts until all the debts are paid off.
Dave Ramsey is the number one advocate for the debt snowball method. He hosts a popular personal finance radio show.
Analyzing the Debt Snowball Method in More Detail
Note that when determining the order in which the debts will be paid using the debt snowball method, the interest rate is not a determining factor.
If the debtors started with paying debts with the largest interest rate first (a process known as debt avalanche), granted that the rate would go down in the future, but the motivation to keep paying is beaten by the debt snowball method by a long margin.
This is because the debtor feels a sense of accomplishment after succeeding on paying the first debt. By getting rid of the most manageable debt first, the list keeps getting shorter.
Compare this with the debt avalanche method. It is likely that the higher interest loan is also the largest debt on the list. Starting with this will take the most time to complete during which time the debtor may lose the motivation to pay.
Best Way to apply the Debt Snowball Plan
Let’s start with a simple example, shall we?
Assume a debtor can set aside $500 each month to pay all his 3 debts as follows:
- Credit card debt worth $1,600 (with a minimum monthly payment of $100)
- An auto loan debt of $4,700 (minimum monthly payment of $300)
- Student loan worth $10,700 (minimum monthly payment of $300)
Our guy can afford to put aside $1,000 each month towards paying his debts. Using the debt snowball plan, he will spend $700 on the minimum required to pay the debts each month.
The remainder, (which is $300) will be put towards clearing the smallest loan, (the credit card debt).
After a few months, the credit card debt will be paid off completely and now our guy can focus on paying the auto loan debt of $4,700.
Now he will be spending $300 on the student loan and auto debt loan each while also putting in the remaining $400 to the auto debt loan.
And after he completely pays this one, what remains is the $10,700 student loan. Our debtor can now pay all $1,000 to the student loan (which will also have considerably gone down in the months passed due to paying the minimum requirement).
Why the Debt Snowball Method Is the Way to Go
Simply put, the debt snowball method works!
Imagine how it would feel like to pay off just one of your debts. That’s an extra weight off your shoulders, right?
You experience a kind of high that motivates you to face the next, larger debt with confidence. And once you are able to tackle this too, you may notice your behavior and spending habits starting to change as you become more conscious of where you put your money.
Soon you may find yourself with more money to put towards paying your debts and end up paying your debts faster than you had otherwise anticipated.