Debt Snowball Definition: Everything You Need to Know
While it’s true that debt can quickly accumulate, the debt snowball tactic can guide you pay it off far more quickly than if you were to make only threshold installments.
One of the techniques that you can utilize to work toward paying off your debt and eventually getting out from under it is known as the debt snowball technique.
To put it another way, you commence by paying off the debt that has the lowest balance initially, then move on to the debt that has the following highest amount, and so on, until you eventually come to the debt that has the greatest balance. This is how the process goes.
Building momentum is at the heart of this tactic, which was made famous by the public figure and personal finance expert Dave Ramsey. By paying off one loan after another, the expectation is that you would gradually build up a sense of personal fulfillment.
What Exactly Is The Debt Snowball Method?
Dave Ramsey, a monetary expert, is credited with popularizing the debt snowball technique. The goal of the debt snowball technique is to keep you motivated while you work to eliminate your debt. Motivating yourself to pay off debt is essential because it can take years.
It is recommended that you begin repaying your debts with the cheapest balance initially and work your way up using the debt snowball technique. In order to get out of debt faster, it is recommended to prioritize the cheapest debts initially and utilize the money freed up to pay them off.
When one debt is paid off, the money allotted for it is moved to the next cheapest debt, and so on, until all of the debts are repaid. This is known as “snowballing,” because the installments on the cheapest debts pile up to the next cheapest debt. This process will continue until all of your debts have been paid.
How Do Debt Snowball Methods Work?
When you utilize the debt snowball technique to eliminate your debt, you begin by making a list of all of your debts and then sorting them from cheapest to largest. Spend as much as you can afford on the cheapest debt initially. Pay the bare threshold on your other monthly bills while you do this.
After you’ve repaid your cheapest debt, put the money you would have utilized there toward your next cheapest debt. Keep making the bare threshold installments on your other obligations. Don’t stop until you’ve paid off all of your debt.
The settlement of any outstanding balance is a success. Though it might not reduce your interest costs, this technique for repaying debt could serve as a powerful motivation to stay on track.
How to Use the Debt Snowball Method?
There are only four basic steps involved in the snowball technique.
Step 1 – Make a complete list of your monetary obligations, aside from the mortgage. Create a list of debts ranging from the cheapest to the largest balance.
Step 2 – Every month, pay the threshold amount on all balances except the cheapest one and put as much money as you can toward that one. The best way to attack your cheapest balance without jeopardizing your other monetary obligations is to examine your budget carefully and determine how much you can put toward it each month.
Step 3 – Apply the surplus funds from repaying the cheapest balance to the installment of the next cheapest balance. And naturally, you should keep up with your other threshold installments as well.
Step 4 – Do this again and again until you have no outstanding debt.
Now, listen up, before you begin to argue about the interest rates. If the interest rate on your biggest debt is also the highest, paying it off will take an incredibly long time.
But if you stay the course (without considering interest rates), you’ll be able to celebrate the swift elimination of even your cheapest debt. You need that feeling of anticipation to push you forward until you have repaid all of your debt.
Example of Debt Snowball Method
Using a real-life example is the best way to grasp this technique. Let’s pretend you owe money on four accounts:
- $500 medical bill with a $50 installment
- $2,500 credit card debt with a $63 installment
- $7,000 car loan with a $135 installment
- $10,000 student loan with a $96 installment
If you want to utilize the debt snowball technique, you should pay the threshold on all of your other debts except for the $500 medical bill. You’re so dedicated to your objective that you decide to supplement your income with a part-time gig that brings in an excess of $500 every month.
With a monthly installment of $550 (the $50 threshold plus $500 additional), your medical debt will be repaid in exactly one month. Your credit card debt will be reduced by $613 ($550 + the $63 threshold monthly installment) once you apply the extra $550 toward it. About four months from now, you can joyfully tear up that credit card.
A total of $748 per month will be thrown at the car loan ($613 plus $135). In 10 months, you’ll be driving away in a car that you really own.
You can put $844 per month toward your student loan by the time you get to it (your student loan is likely your largest debt). In other words, in 12 months, you will have sent the final installment.
If you utilize the debt snowball technique and are disciplined about making extra installments and sticking to your repayment schedule, you can eliminate $20,000 in debt in just 27 months.
Debt Snowball vs. Debt Avalanche: What’s the Difference?
The debt snowball tactic serves as inspiration for the debt avalanche technique, which entails organizing bills in a particular order.
When consumers utilize the debt avalanche technique, on the other hand, they prioritize repaying the loan with the largest interest rate initially and then utilize the additional cash to settle the debts with the cheapest interest rates. This is done in order to reduce the total amount of interest paid over time.
The debt snowball technique is your greatest option if you are drowning in debt at this point in your life. The path to economic independence might not appear to be as difficult when viewed from this angle. You may want to consider the debt avalanche if you have a lot of high-interest debt and are trying to save as many funds as possible on interest installments.
The debt avalanche technique involves making settlements on your debts in the sequence of descending interest rates, with the debt that has the highest interest rate being paid off initially.
Is the Debt Snowball Method Effective?
Mathematically, the debt snowball technique is more expensive and takes longer to implement than other debt reduction options like debt consolidation loans and debt management programs.
In reality, the debt snowball technique is just as effective as a loan or debt management program if you place the appropriate numbers in the appropriate categories for the appropriate period of time and let momentum do its thing.
The debt snowball technique is a motivational program that can guide you get out of debt, but it will cost you more money and time (sometimes a lot more money and time) than other debt-relief options. Your success depends entirely on your own techniques.
Customers who feel they could benefit from some impartial advice about their monetary decisions are encouraged to seek assistance from a nonprofit debt counseling service.
Debt Snowball Method Alternatives
Alternatives to the debt snowball exist if you find that it isn’t a good fit for you:
- Debt management. You can consolidate all of your unsecured debts into one manageable monthly installment with the guide of a debt management plan, the best of which are typically provided by non-profit consumer credit counseling agencies. It could make making installments easier and shorten the time it takes to pay off your debt.
- Debt settlement. Debt settlement typically entails making a single, reduced installment on all of your outstanding debt. One option is to bargain with the creditor directly, while another is to hire a debt settlement company to handle the negotiations on your behalf.
This choice has a lot of potential benefits, but it also has a lot of possible drawbacks. Before deciding to settle your debts, you should educate yourself on the process and its nuances.
- Debt avalanche. Like the debt snowball, the debt avalanche arranges debtors’ accounts in a predetermined sequence.
The debt avalanche technique differs from the snowball technique in that it encourages debtors to concentrate on the loan with the biggest interest rate initially, then utilize the extra cash to chip away at the next highest-interest debt, and so on.
If your lowest debt is also the one with the highest interest rate, the debt avalanche will be more beneficial right away. Nevertheless, you can reduce your overall costs by concentrating on paying down the highest-interest credit card balances initially. And that’s advantageous.
- Debt consolidation. A debt consolidation loan could guide you simplify your monetary situation by allowing you to repay multiple debts with a single installment. A lower interest rate may be the side effect of this tactic, which could make it much simpler to repay your debts.
- Debt snowflaking. The term “debt snowflaking” refers to the practice of setting aside very small sums of money each month to put toward paying off debt. For instance, you may have found a dollar bill in the supermarket parking lot or received a five-dollar rebate for a product purchase. You can utilize this “lost” cash to pay down your debt.