What is the Debt Snowball Method?
The debt snowball method is a debt repayment strategy where an individual pays off their debts in order of smallest to largest balance, regardless of interest rate. The idea behind this method is that by paying off smaller debts first, an individual will see progress more quickly and be motivated to continue paying off their debts.
For example, let’s say an individual has four debts: a credit card with a $1,000 balance and a 15% interest rate, a personal loan with a $2,500 balance and a 10% interest rate, a car loan with a $5,000 balance and a 7% interest rate, and a student loan with a $10,000 balance and a 5% interest rate. Using the debt snowball method, the individual would focus on paying off the credit card first, then the personal loan, then the car loan, and finally the student loan.
The debt snowball method can be effective for individuals who struggle with motivation or feel overwhelmed by the amount of debt they have. By focusing on small wins and seeing progress quickly, individuals may be more likely to stick with the plan and pay off all of their debts. However, it may be more financially efficient to pay off high-interest rate debt first.
Debt Snowball Best Practices
1. Make a list of all of your debts: Write down the balance, interest rate, and minimum payment for each debt you have. Consider the type of debt because certain types of debt such as credit card debt, often have higher interest rates than other types of debt, like student loans. It may be more beneficial to pay off high-interest debt first, as it can save you money in the long run.
2. Prioritize your debts: Arrange your debts in order of smallest to largest balance, regardless of interest rate. List of all your debts, including interest rates and minimum payments. Prioritize paying off the debts with the highest interest rates first, while making minimum payments on the other debts. Note: If you have multiple debts with similar interest rates, it may make sense to pay off the smaller debts first. This can help you gain momentum and motivation as you see your progress in paying off your debts.
3. Set a budget: Determine how much money you can allocate each month to paying off your debts. In addition to determining how much money you can allocate to paying off your debts, it’s important to create a budget that includes all of your income and expenses, such as housing costs, utilities, transportation, food, and entertainment. Be sure to track your spending and adjust your budget as needed to ensure that you are living within your means and making progress towards your debt repayment goals.
It can also be helpful to use budgeting tools and apps to simplify the process and stay on track. A budget app such as Mint, YNAB (You Need a Budget), or Personal Capital (Empower) can help you understand your income, expenses, and debt obligations.
By using a budget app to create a realistic budget, you can identify areas where you can cut back on expenses and use that money to pay down your debts. Finally, be sure to include a category in your budget for unexpected expenses or emergencies, so that you don’t have to rely on credit cards or loans to cover these expenses.
4. Pay the minimum on all debts: Make the minimum payments on all of your debts each month, except for the debt with the smallest balance. While paying off your debts, avoid taking on new debt. Be cautious of credit card offers and loans that may have hidden fees or high interest rates.
5. Attack the smallest debt first: Apply all additional funds you have each month to paying off the debt with the smallest balance. Once that debt is paid off, move on to the next smallest debt. One benefit of attacking the smallest debt first, also known as the debt snowball method, is that it can provide a sense of accomplishment and motivation as you see the number of debts decrease. By paying off the smallest debt first, you can quickly eliminate one of your debts and then use the money you were paying towards that debt to pay off the next smallest debt.
This can create a positive feedback loop that helps you stay motivated to continue paying off your debts. Additionally, by eliminating smaller debts first, you can free up cash flow to tackle larger debts with more ease. However, keep in mind that attacking the smallest debt first may not always be the most financially optimal strategy, as it may not result in the lowest overall interest payments.
Celebrate Your Wins
As you pay off each debt, celebrate the progress you’ve made. This will help you stay motivated to continue paying off your debts.
1. Re-evaluate your budget: As you pay off debts, you may have more money to allocate towards paying off the remaining debts. Re-evaluate your budget and adjust your payments accordingly.
2. Keep your credit score in mind: While paying off debts, it is important to keep your credit score in mind. Late payments or defaulting on loans can have a negative impact on your score.
3. Keep an eye on your credit report: Regularly check your credit report to ensure that your debts are being reported correctly, and that you don’t miss any payments. You can get free credit reports from each of the three major credit bureaus annually at AnnualCreditReport.com. You can also get your credit score directly from the three major credit bureaus: Experian, Equifax, and TransUnion.
4. Seek professional help if needed: If you find that you are unable to make headway on your debt, consider seeking professional help from a financial coach or credit counselor. They can help you come up with a plan that works for you.
Final Thoughts
Effective debt management can help you become debt-free and achieve your financial goals. Managing debt is essential for personal finance success. By mastering the debt snowball method and following these strategies, you can become debt-free and enjoy the benefits of financial freedom. Remember that effective debt management requires discipline and commitment, but the rewards are well worth the effort.