Odds are, you’ve heard of the debt snowball method from one finance guru or another. It’s very popular in the personal finance community. The technique is simple, but can have some pretty serious effects on both your finances and your mental health. Check out the rest of the article below to learn how and why it works!
Why Call It a Debt Snowball?
One of my fondest memories from growing up in Iowa is making a good, old-fashioned, snowman. And how do you make a snowman? You start by grabbing a handful of snow and pressing it into a ball in your hands. Then, you roll the ball in the snow around you. As the snowball rolls around, it picks up more and more snow, making the small snowball bigger and bigger.
Before you know it, the ball is so big that you can’t roll it with just one hand. Using two hands, you keep rolling, picking up exponentially more snow as the snowball gets even bigger. Eventually, the snowball gets so big that you nearly can’t lift it.
That’s when you stop, make a new ball with your hands, and repeat. Stack the giant snowballs atop each other, add a corncob pipe, a couple of branches, and two pieces of coal. Why am I telling you all this? because this is also how you tackle debt with the debt snowball method. But, instead of debt, you use cold, hard cash (and no corncob pipe or other accessories).
The Debt Snowball Method Steps
You create a debt snowball by starting small, much like how you start a snowman with a small snowball.
First, make a list of all your debts, and sort them by the amount owed for each, from smallest to largest.
Second, make sure you are making minimum payments on all of these debts.
Third, take any money you have left at the end of each month, and throw it at your smallest debt.
Check that out! Three very simple steps. Here’s the idea: the faster you pay off a loan, the faster you have more money to throw at the other loans. So, starting with the smallest loan means you’ll have extra money faster than if you’d paid off any other loan.
Think of the extra money you pay each month as your snowball. When you focus on paying off the smallest loan first, you end up with extra money to go towards the other loans. When you pay off a loan, your extra money snowball grows. Then, you throw all this money at the next smallest loan. Pay that off, and the ball grows faster.
Eventually, you only have one loan left, and a giant snowball of money to take care of it.
Paying off loans this way is like throwing a little snowball down a snowy mountain side. With the right momentum, the ball will grow bigger, and faster! Eventually, it will steamroll over anything in its way.
That, my friends, is how you take out your largest loan. Not with a whimper, but with the bang of a giant money snowball.
A Debt Snowball Method Example
Suppose you had the debts in the table below. I already ordered them from smallest amount owed to greatest amount owed, so we’ve finished step one.
|Loan Type||Loan Amount||Minimum Monthly Payment|
|Student Loan #1||$15,000||$80|
|Student Loan #2||$20,000||$150|
For the second step, you need to figure out how much you need to pay in minimum payments every month. By adding up the Minimum Monthly Payment column, we know the total minimum payment is $350/month.
For the third step, figure out how much extra money you have to give to the smallest balance (starting with the credit card). Let’s say you can scrounge up another $450 every month. You can add the $450 to the credit card minimum payment of $50, for a total of $500 dollars towards the smallest loan each month.
At that rate, you’ll finish paying off the credit card in 6 months! Then, you’ll not only have the extra $450 for the next loan, but also the $50 that’s no longer going towards the credit card minimum payment. At the rate this snowball grows, we could pay off everything in just over 7 years. That’s pretty good for paying off $55,000!
And, the more money you add to that, the faster it goes! Hopefully you’re able to pay more than just an extra $450 after that much time. Also, you might’ve noticed I didn’t include the interest rates in the table above. That’s because the interest rates don’t really matter. Sure, they’ll make you pay a little more than $55,000 over those nearly 6 years, but they don’t impact in what order you pay down the loans.
The Financial Impact of the Debt Snowball Method
Financially, the best part about the debt snowball is that it’s a dedicated payoff strategy. The debt snowball method is not the best payoff method, mathematically, but it’s definite better than nothing. The debt avalanche method is actually mathematically superior. But that’s a discussion for another post.
Fact is, people with any strategy are more likely to tackle debts faster than those with no strategy at all. Also, paying off the small debts first (even if they’re not the largest interest rates), actually has its benefits.
For example, consider your DTI (debt-to-income) ratio. This is a ratio that everyone has. It’s basically all of your monthly debt payments divided by all of your monthly income. If you use the debt snowball method, you help your DTI ratio drop faster, since you’re eliminating debt payments quicker. This is really helpful when trying to qualify for mortgages.
The Emotional Impact of the Debt Snowball Method
The emotional impact of the debt snowball method is probably more powerful than the financial impact. Paying off debt is hard. Sure, financially, paying off debt hurts your bank account. But, paying off debt can start to take a real, emotional toll on a person. Debt, like anything else, can become emotional baggage.
Fortunately, the debt snowball method is designed to help with the emotional toll. If you were to only make minimum payments and pay off the largest loan first, that would feel like forever. The longer it takes to pay off a single loan, the longer you feel like you’re not making any progress.
But, with the debt snowball method, you start making progress right away. By paying off the smallest loan first, you start making real progress quickly. Since each loan payoff allows more money to pay down the next smallest loan, you eliminate that one quicker too.
By always paying off the smallest loan and rolling those payments into the next smallest loan, you’re constantly seeing improvement. This kind of positive feedback can help people feel like they’re making a difference, which encourages them to keep going.
Paying off debt can be a little like going on a diet. You make sacrifices and hope to see an improvement. If you keep seeing small improvements, you stay encouraged to keep up the plan. Most people give up diets when they don’t see improvements fast enough. The debt snowball method helps prevent that.
Criticism of the Debt Snowball Method
Despite the debt snowball method working well for thousands of people, some people still criticize it. They like to point out it’s not the fastest way to pay down loans, nor save the most money. They’re not wrong, but the fact is, it works for a lot of people.
For people who know they might struggle with another strategy that doesn’t give results as quickly, this plan is great. It’s better to complete something that is sub-optimal than to give up on something optimal. You need to know your personality and do what’s best for you, not someone else.
What do you think about the debt snowball method? Have you tried it before? Do you think the psychological gains outweigh the small financial inefficiencies? let me know your thoughts in the comments below!
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