If you feel trapped in debt, you are not alone. As of September 2022, consumer debt in the US is $16.5 trillion, with the average American, having $96,371 in debt. The overall debt figure includes credit card balances, auto loans, student loans, mortgages, and more.
While borrowing money is not necessarily a bad idea to achieve long-term financial goals, keeping multiple debts at the same time can be overwhelming. The longer you keep your debts open, the more you end up paying interest over time. Plus, any default in payment can affect your credit score negatively and add to your financial burden.
So, it is very important to find out the best debt repayment strategy that suits your financial situation. That way you know exactly where to channel your payments to repay your debt systematically and manage your income more efficiently.
Here in this article, we will discuss a popular strategy called Debt Snowball and how you can implement it.
What is debt snowball strategy?
The debt snowball is a debt repayment strategy where you focus on paying off your smallest debt balance first before moving on to the bigger ones. In this strategy, you list down your debts in ascending order starting with your smallest debt balance, paying off your smallest debt as much as possible while paying minimum payments to the remaining debts.
Once the lowest debt is paid off, you can use the fund previously allocated for your lowest debt repayment to pay off your next lowest debt, thus building momentum and “snowballing” your repayment toward your next debt. You keep on “snowballing” your repayment till all your debt is paid off.
Each balance payoff gives you a psychological boost that will motivate you to keep paying off your debt. Since you start with the smallest debt, you get the much-needed early boost that keeps you on track.
Key takeaways:
- The debt snowball is a popular debt repayment strategy, popularized by personal finance guide Dave Ramsey
- The debtor pays off the smallest debt first before moving on to the next smallest debt and so on
- Gives a psychological boost to stick to the debt repayment plan
- There is another popular strategy called Debt Avalanche that focuses on paying off the debt with the highest interest rate first
- Both methods have their pros and cons
How to implement the debt snowball method?
Now that you have a basic understanding of the method, let’s break the concept in an easy step-by-step process that you can easily implement in your debt repayment strategy.
Step 1: List down all your debts and arrange them in ascending order starting with the smallest one. For example, suppose you have four debts of $1000, $2000, $500, and $1500
After arranging them, the order will be $500, $1000, $1500, and $2000
Step 2: Each month, pay as much as possible for your smallest debt i.e. $500 debt, and for the remaining debts, pay the minimum payment.
Step 3: Once you pay off the $500 debt, use the amount that was previously allocated for that debt to pay off your next smallest debt i.e. $1000 debt, and pay the minimum payment for the other two debts.
Step 4: When you finish paying off your $1000 debt, use the amount that was previously allocated for $500 and $1000 debt, to pay off your next smallest debt, i.e. $1500 debt, and pay the minimum payment for the $2000 debt.
Step 5: Repeat the process till you pay off all your debts.
Pros and cons of debt snowball method:
Like every other debt repayment method, this also comes with some advantages and disadvantages. Let’s take a look at the pros and cons of this strategy that can help you decide if this is the right strategy for you.
Pros:
Keeps you motivated
Paying off the smallest debt quickly gives you a psychological win since you now have one less debt to worry about. As the number of debts keeps decreasing, you feel motivated to stick to your debt repayment plan in a disciplined way.
Easy to implement
The debt snowball method is easy to implement compared to other debt repayment strategies since you don’t need to calculate annual percentage rates (APRs) for all your debt. You can simply rank your debts in ascending order and start with the smallest one.
Helps you improve money-management skills
It can very difficult and even frustrating sometimes if you have to keep paying for multiple debts for long terms. With this method, as your debt pile keeps decreasing, you will be able to manage your income more efficiently. It helps you positively in your financial health.
Cons:
Ignores interest costs
Since this method does not consider the interest rates of your debts, it is not the best method to save money on your interests. You might end up paying more interest over time.
If your higher debts incur higher interest rates this might not be the best strategy. However, in situations where smaller debts (like credit card bills) incur higher interest rates, this can be an ideal strategy.
Longer repayment period
It usually requires a longer repayment period using this method. If the interest rates on your higher debts are on the higher end, the debt avalanche method could be a better approach.
When should you use the debt snowball method?
- If the interest rates are similar for all your debts
- If the interest rates on your higher debts are not significantly more than that of your smaller debts
- If the smaller debts incur higher interest rates
- If you need the motivation to stick to your debt repayment plan
- If you are someone who finds it encouraging to see your debt paid off one by one
The bottom line:
Living in debt can be stressful and figuring out how to pay debt off can be overwhelming at times. The Debt Snowball method is a simple and effective strategy to pay off your debt while making sure you stay motivated to stick to your debt repayment plan. It can be very effective for those who feel overwhelmed to carry multiple debts in parallel for a long time. Ultimately, getting out of debt is more important than making sure you pay as little as possible along the way.
