The debt snowball is a strategy that uses the balances of your debts to determine which order you should use to pay them off. Using this method, you will primarily focus on repaying your smallest debt obligations first while making the minimum required payments on any other debts that you have due.
Once the balance on a particular debt is paid fully, then the goal is to use the funds that were allocated to repaying that debt and use it to help pay down the account with the second lowest balance. As you continue with each subsequent debt you are building a snowball that will systematically cancel out your balances until each one is successfully repaid.
How Does the Debt Snowball Method Work?
The debt snowball method works by assessing all of your existing credit, collections, and other financial obligations. Once you determine the amount of money that you can safely sacrifice towards your debts, then you will pay off each one with the smallest balance due being first. Any remaining funds will go towards your other balances by making only the minimum payments on each one, regardless of what type of debt it is.
First coined by personal finance expert Dave Ramsey under his Baby Steps technique, it teaches you a reward centered methodology to repay your debts little by little, instead of being overwhelmed. Although the method is simple to use, it should only be started after you have established an emergency fund of at least $1,000.
When utilizing this method, the balances should be ordered by the amounts owed, without regards to the interest that will continue to accrue as the debt is being taken care of. Therefore, those with higher interest rates will take a little longer since it accumulates on a daily, monthly, or annual basis, depending on what type you are dealing with.
How to Use the Debt Snowball Method to Pay Off Debt
The debt snowball method can be used to pay off debt by following four steps. Each one will help you to rid yourself of unwanted debt and provide the motivation to keep going by realizing your achievements no matter how small.
First Step
Begin by listing all of your debt with the exception of your home mortgage. These debts should be re-organized to reflect the balances in order amount due from the least to the greatest.
Second Step
Every debt should have the monthly required minimums paid each month, while putting the rest of your budgeted cash towards fully repaying the one with the smallest balance. The total amount used to create your debt snowball, should not affect the rest of your financial obligations such as housing, utilities, or other required expenses
Third Step
Once the initial debt is zeroed out, the funds that were being used for repayment, should be rolled over into paying off your debt with the second smallest amount due. Any remaining funds should still be applied towards covering the minimum amounts on other existing debts.
Fourth Step
As the snowball keeps building, you will repeat steps 1 through 3 until every debt on your list is paid in full. A successful debt snowball method will have you completely debt free in a matter of months or years.
Paying off your debts in this manner can effectively change your behavior with money in a positive way. By following the process through, not only will you be knocking out your debts at a relatively fast pace, but you will also be allocating hundreds of dollars each month that can be used towards ramping up savings, once the debts have been paid off.
Example of the Debt Snowball
An example of the debt snowball is to look over a series of debts in regards to the balances owed along with each monthly payment. Then you can calculate how much you will need to make the required amount each month on the three largest ones while putting the rest of your available funds towards fully taking care of the smallest one.
| Debt Balances | Monthly Payment |
|---|---|
| $30,000 student loan | $350 due monthly |
| $10,000 personal loan | $125 due monthly |
| $5,000 credit card | $100 due monthly |
| $1,000 dental bill | $75 due monthly |
| $250 second credit card | $20 due monthly |
In the above example you would pay the minimum amount on every bill except for the smallest one, which is the second credit card debt for $250.00. With a budget of $1,000 to put towards your debt snowball, your payments would look like the following.
First Month
- Second credit card – $270 per month (paid off with the first payment)
- Dental bill – $75 per month
- Credit card – $100 per month
- Personal loan – $125 per month
- Student loan – $350 per month
Second Month
- Dental bill – $325 ($75 required plus an extra $250 from second credit card pay off)
- Credit card – $100 per month
- Personal loan – $125 per month
- Student loan – $350 per month
Each time a debt is paid, then the allocated funds would go towards the next smallest debt the following month, until every single one is fully paid down to zero.
Advantages of the Debt Snowball Method
Some advantages to using the debt snowball method in your quest to become debt free are developing a positive relationship with money, overcoming stress, and learning to stick to a budget each month. In time, your confidence may also improve as you are on a journey to being financially stable.
Disadvantages of the Debt Snowball Method
A common disadvantage of using the debt snowball method is the fact that you will pay more interest by paying off debts with higher interest rates over a longer period of time. Since your balances will remain high during the repayment period, your credit score may experience a temporary negative impact as well.
Conclusion
Debt is one of the largest stressors that people encounter in life. By developing a plan to become debt free such as the debt snowball method, you can build a better relationship with your finances, save thousands of dollars, and pave your way to a better future.
