Get on a roll with this super effective debt repayment strategy...
When it comes to personal finances, getting out of debt is usually a priority goal.
But thinking about ways to tackle your debt can begin to feel overwhelming.
If you’re not sure where to start, the debt snowball method could be the perfect system to help you get out of debt faster. Not only is this debt-reduction strategy simple to master, it’s also really motivating to see your debts quickly diminishing.
We’ve put together a handy guide to help you understand the ins and outs of this strategy so you can get started on dealing to your debts, today. Our guide covers:
- How the debt snowball method works.
- Putting the debt snowball method into action.
- Ways you can leverage the debt snowball method.
First, let’s look at what this debt reduction method is all about!
What is the debt snowball method?
Think of a snowball as it rolls down the slope. It starts out small and moves slowly, but as it continues to roll, it grows by accumulating more snow while picking up speed.
That’s the theory behind the debt snowball method; you’ll start by crushing the small debts, quickly gaining more momentum to deal to the bigger debts, regardless of interest rate.
Here’s how it works
The debt snowball system is super easy to implement. You focus on paying your smallest debt balance first, while paying the minimum amount on your others.
Once you’ve paid off the smallest debt, you focus on the next smallest debt, and so on and so forth until you’ve gradually moved onto your larger debts and, eventually, all debts are paid off.
Start snowballing your debts with these 6 steps
Here are the basic steps to the system:
- List all your debts in order, from smallest to largest.
- List the minimum payments for each debt. Check your budget to ensure you have these minimum payments covered.
- Calculate how much extra money you can pay toward the smallest debt, over and above the minimum payment. Consider taking on a side hustle for some extra cash or cutting down on expenses.
- Make the minimum payment along with the extra amount towards the smallest debt until the debt is paid off.
- When this is paid in full, add that debt’s minimum payment (plus any extra cash available) to the minimum amount you’re already paying on your second smallest debt.
- Repeat until all of your debts are paid in full.
The debt snowball method in action
Let’s create a real life example to see just how this works.
First, you’d create a list of debts in ascending order along with monthly minimum payments.
- Credit card #1 of $900. Minimum payment = $60
- Credit card #2 of $2200. Minimum payment = $150
- Car loan of $4500. Minimum payment = $220
- Student loan of $8000. Minimum payment = $300
Let’s say you have an extra $120 a month, either through cutting expenses or from extra income.
Using the debt snowball method you’d make minimum payments on all debts except the smallest debt (Credit card #1). For this debt, you’d pay the minimum of $60 plus the $120 extra cash you’ve accumulated.
After just five months, you would have paid off the smallest debt.
Congratulations – that’s one debt down!
WHILE YOU'RE HERE:
- Pay off your credit cards, and fast, with these 5 top tips!
- Paying off your debts? Avoid these 5 mistakes every Kiwi makes
- Consolidating your debts and repaying your loans is easy. Here's how!
The next smallest debt is Credit Card #2. For this debt, you’d meet the $150 minimum and then add the additional $180 in payments you’ve been making to Credit Card #1. That’s a total of $330. For the other debt balances, you would continue to pay the minimum due amounts.
Seven months later, and the second Credit Card would be fully paid off.
The smallest debt is now the car loan, and once again you’d attack it in the same way, with a minimum payment of $220, plus the accumulated minimum payments of the debts you’ve paid off ($150 plus $60), as well any extra cash, while still meeting minimum payments on the other larger debt.
Like a snowball, your debt repayments are growing, so when it comes to paying off the larger debt you’ll be applying $850 a month to the student loan! With those kinds of payments, you’ll be living your life debt-free in next to no time.
How best to leverage the debt snowball for you
Research shows the debt snowball system does help people reduce and eliminate debt.
To really make this system work for you, it’s vital that you don’t incur any extra loans, credit cards, or other debts. That would defeat the whole purpose of this exercise and undermine the methodology.
Consider setting up an emergency fund to ensure you don’t accrue more debt. A fund for those unexpected expenses - like an emergency visit to the dentist, or buying a new radiator for the car- ensures you won’t be adding to your debt.
If you are disciplined with your finances, cynics of the debt snowball method recommend the ‘avalanche method’ where you pay the highest interest debt first, as the better option.
Dave Ramsey however, who made the debt snowball method popular, says while that recommendation be partly true, personal finance is mainly “20 percent knowledge and 80 percent behaviour...” and the debt snowball method is a more motivating approach.
It's time to melt your debts away
As a debt reduction system, the debt snowball method works because it’s simple to follow and motivating to commit to when your debts are crushed quickly, one by one. In fact, experts say the psychological benefits to using the debt snowball system are one of the biggest reasons it works so well.
As you make inroads into your debt and have less creditors to pay each month, you’re likely to be more inspired to find - or save - more cash to channel toward debt reduction, compounding your results.
With these actions and behaviours, you’ll quickly form the foundation of good financial habits!