How to Use the Debt Snowball Method to Become Debt Free
The debt-snowball method of debt reduction is a well-known formula that has been recommended by many popular personal finance experts such as Dave Ramsey.
It is a debt repayment strategy that primarily involves paying off debts with the smallest balances first. Application of the debt-snowball method is usually used to cut debts on revolving lines of credit and small loans (rarely involves mortgages).
In addition to wholehearted commitment and perseverance, the success of the debt-snowball method requires enough income to make minimum payments on all balances plus extra cash flow, which is key to starting your own debt-snowball.
How to Start Your Own Debt Snowball
1. List all your outstanding debts, along with minimum payment amounts, starting from the smallest balances to the lowest balances.
2. Make your monthly minimum payments on all balances except the smallest one.
3. For the debt with the smallest balance, determine the amount of extra cash you can apply to this payment on top of the minimum payment.
4. When the smallest balance has been paid in full, add the extra amount from the old payment of the eliminated debt to the minimum payment of the second smallest balance and this is your monthly payment for the second smallest debt.
5. Repeat steps two through four until you have cleared all your debt.
The debt-snowball method mimics the concept of a snowball rolling downhill. As the snowball rolls, it picks up more snow and thus gains size and speed. Since larger balances often require larger minimum payments, your debt-snowball payments will grow as your begin tackling larger debts.
An Example of a Debt Snowball
Let’s assume a person had an extra $75 every month and started with the following balances:
- Credit card A: $500 balance - $25 minimum payment
- Credit card B: $2,000 balance - $50 minimum payment
- Auto loan: $4,000 balance - $200 minimum payment
Assuming this person doesn’t incur new debt, the monthly payments for the next five months would be:
- Credit card A: $100 ($25 minimum + $75 extra)
- Credit card B: $50 minimum payment
- Auto loan: $200 minimum payment
After five months, credit card A is paid in full and this person will have the following balances:
- Credit card B: $1,750 balance
- Auto loan: $3,000 balance
The monthly payments for the next 12 months would be:
- Credit card B: $150 ($50 minimum + $75 extra + $25 freed from credit card A, the 12th month’s payment is $100)
- Auto loan: $200 minimum payment
After 12 months, credit card B is paid in full and this person will have the following balance and payment amounts:
- Auto loan: $600 balance - $300 payment (balance paid in full in twomonths)
The Psychological Win is Key
Many critics would protest that the debt-snowball method isn’t the most financially wise approach to debt reduction. Others would advise on paying the debts with the highest interest rates first, which would save consumers more money in the long run.
Support for the debt-snowball method remains strong because it offers the quick psychological win that many believe to be the key to removing debt. Dave Ramsey, an avid teacher of the debt-snowball method, finds that clearing the small balances first fuels the motivation to continue striving for debt freedom.
