As I had mentioned in last weeks post the debt snowball method is more about behavior modification rather than saving the most on interest payments. You are most likely thinking to yourself well how is that going to get me to early retirement if I will be paying more in interest payments to get there. Getting into the right mindset for achieving this goal is the first thing. Psychologically this will get the ball rolling for you as you start to use the method and then we can switch over to the Avalanche method as time goes on.
Here’s How the Debt Snowball Method Works
The debt snowball method is a debt reduction strategy where you pay off debts in order of smallest to largest, gaining momentum as each balance is paid off. When the smallest debt is paid in full, you roll the money you were paying on that debt into the next smallest balance.
It looks something like this:
Step 1: List your debts from smallest to largest.
Step 2: Make minimum payments on all your debts except the smallest.
Step 3: Pay as much as possible on your smallest debt.
Step 4: Repeat until each debt is paid in full.
An Example of the Debt Snowball
Say you have the following four debts:
1. $500 medical bill ($50 payment)
2. $2,500 credit card debt ($63 payment)
3. $7,000 car loan ($135 payment)
4. $10,000 student loan ($96 payment)
Using the debt snowball method, you would make the minimum payments on everything except the medical bill. For this example, let’s say you have an extra $500 each month from cutting your expenses down to the bare minimum. This type of money can come from the saving methods that I post weekly in the start saving section.
Since you’re paying $550 a month on the medical bill (the $50 payment plus the extra $500), that debt will be done in one month. You would then take that $550 and attack the credit card debt. You can pay $613 on the plastic (the freed-up $550 plus the $63 minimum payment). In about four months, you’ll wave goodbye to the credit card. You’ve paid it off!
Now punch that car loan in the face to the tune of $748 a month ($50 + $63 + $135 + $500). In 10 months, it’ll drive off into the sunset. Now you’re on fire!
By the time you reach the student loan—which is your biggest debt—you can put $844 a month toward it ($50 + $63 + $135 + $96 + $500). That means it will only last about 12 months.
Thanks to your hard work and sacrifice, you have paid off $20,000 of debt in only 27 months using the debt snowball method! Congratulations!
The key amount here is $500. With that extra $500 being directly paid towards the principal of the loan is what accelerates this method. Which is why before getting into the mindset of paying off debt you need to start saving everywhere you can.
Why Does the Debt Snowball Method Work?
The debt snowball works because it is about behavior modification, not math.
In the example, if you start paying on the student loan first because it’s the largest debt, you won’t see it leave for a while. You’ll see numbers going down on a page, but pretty soon you’ll lose steam and stop paying extra and you’ll still have all your debts hanging around.
When you ditch the small debt first, you see progress. That one debt is out of your life forever. The second debt will follow soon, and then the next. When you see the plan working, you stick to it. When you do that, you’ll succeed in becoming debt-free.
Then by the time you’re paying on the bigger debts, you have so much more cash freed up from paying off the earlier ones that it creates a debt snowball. Suddenly, you’re putting hundreds of dollars a month toward your debts instead of a few bucks here and there. You build momentum, and that changes your behavior and helps you get out of debt for good.
I personally used the debt snowball method when I first got started paying down my student loan payments. In next weeks post I will talk about the Debt Avalanche method if you want to save the most money on debt interest payments.