What is the Debt Snowball Method and How Does it Work?
January 29, 2024
Learn how the Debt Snowball Method can help you effectively tackle your debt and achieve financial freedom.
Are you haunted by the four-letter word that starts with D and ends with T? Then it's time to declare war on it and adopt a solid plan for paying off that debt. Eliminating debt can be approached in a variety of ways. One of the most popular is the five-step Debt Snowball Method. Let's dig into this debt-busting strategy that has the potential to transform your financial future.
How the Debt Snowball Method Works
The Debt Snowball Method is a popular debt repayment strategy that can help you eliminate debt and achieve financial freedom. It involves prioritizing debts based on their balances and paying off the smallest debt first while making minimum payments on other debts. As each debt is paid off, the freed-up funds are rolled over to the next debt, creating a snowball effect and accelerating debt repayment.
The main concept behind the Debt Snowball Method is to provide psychological motivation by focusing on small wins. By paying off the smallest debt first, individuals experience a sense of accomplishment and progress, which encourages them to continue their debt repayment journey. This method is particularly effective for individuals who need extra motivation to stay committed to their debt repayment plan.
It's important to note that the Debt Snowball Method does not prioritize debts based on interest rates. While some financial experts argue that paying off high-interest debts first can save more money in the long run, the Debt Snowball Method prioritizes the positive emotional impact that paying off debt yields and helps to build momentum by focusing on paying off smaller debts first.
Set Yourself Up for Success
As is the case with most things in life, having a plan of attack is essential to the success of this debt-busting tactic. This requires you to have a personal budget in place, so you know exactly how much you can afford to direct towards debt payoff. It also requires that you create a list of your debts, balances, interest rates, and minimum monthly payments and create a repayment schedule. Below, we'll show you how to break down this task into bite-size pieces.
Identify Your Debt. And we mean all of it.
The Debt Snowball Method requires you to compile a comprehensive list of all your debts. This includes credit card balances, personal loans, student loans, department or specialty stores, Affirm, AfterPay, etc. The exception is that you should not include your mortgage if you have one. Be sure to include the outstanding balance, minimum monthly payment, and interest rate for each debt.
Creating a list of debts allows you to have a clear understanding of your overall debt situation. It helps you see the bigger picture and prioritize your debts effectively. By having a comprehensive list of your debt, you can easily track your progress and stay organized throughout your debt repayment journey.
Line 'Em Up, Smallest to the Tallest.
Once you have compiled a list of your debts, the next step is to order them by balance from smallest to largest. This means arranging your debts in ascending order based on the outstanding balances. The smallest debt will be at the top of the list, while the largest will be at the bottom.
Ordering debts by balance is a crucial step in the Debt Snowball Method as it determines the order in which you will pay off your debts. By starting with the smallest debt, you can experience quick wins and build momentum in your debt repayment journey. This ordering also helps you stay focused and motivated throughout the process.
The core principle of the Debt Snowball Method is to pay off the smallest debt first while making minimum payments on other debts. allocating extra funds towards the smallest debt until it is completely paid off. Once the smallest debt is eliminated, you take the money that was previously allocated toward its payment and roll it over to the next smallest debt on your list.
What extra funds, you ask? The "extra" funds we are referring to are those that are part of your working budget. This means they are not otherwise allocated for housing, groceries, utilities, health insurance and other basic expenses of everyday life. They are typically identified by reviewing a few months of expenditures to see where you can cut back on unnecessary expenses. This includes money spent eating out, impulse purchases, streaming services and a popular budget buster - the Starbucks run. By reducing discretionary spending, you can apply those extra funds towards debt repayment.
As you pay off each debt using this method, you create a snowball effect that builds momentum and accelerates your debt repayment. The funds from the paid-off debt are rolled over to the next biggest debt on your list, increasing the amount available for repayment and accelerating the payoff schedule. You'll find that as you progress through your debt repayment journey, you will find that your momentum continues to grow, and you become more motivated to eliminate your debts and achieve financial freedom.
Here's an example of how the Debt Snowball method might look in everyday life. You have a medical bill that is $300 and are not being charged interest on it, and two credit cards with balances of $5,000 (at 18.9% APR) and $7,500 (at 25.99% APR). In this scenario, you would focus on paying off the medical bill first. Why? Because that is the debt with the smallest balance. This may sound counterproductive, but you'll be more likely to stick by front-loading your debt-elimination journey with successes.
One Size Does Not Fit All
As you embark upon your journey to pay off debt, remember that there is no one perfect method. The Debt Avalanche method is another strategy, and debt consolidation can also be a very useful tool. You can learn more about it with our free Debt Consolidation. If you'd like to learn more, you can download our free ebook, The Ultimate Guide to Debt Consolidation. You can also use our online debt payoff calculators to chart your path to a debt-free future. Don't forget, we're here to help. Give us a call or drop us a line and let us know how we can help you develop a path to conquering debt.