If you are new to my blog, I have an entire category of blog posts on the topic of debt reduction strategies. My favorite strategy is velocity banking and I discuss how I am using velocity banking to pay off my mortgage in less than 7 years. The Debt Snowball Method is a very popular debt reduction strategy popularized by the finance guru himself, Dave Ramsey. Similar to how a snowball grows larger as it rolls down a hill, the snowball method is where you pay off your debt from smallest to largest, excluding your mortgage. Here is how it works.
Step 1: List your debt from smallest to largest. I will list examples below.
- Credit Card Debt #1: $700, Min Payment $25
- Credit Card Debt #2: $2500, Min Payment $48
- Student Loan #1: $10,000, Min Payment $178
- Car Loan: $14,600, Min Payment $290
- Student Loan #2: $50,000, Min Payment $550
Total Monthly Debt = $1091 in minimum payments.
Step 2: Pay as much as possible on your smallest debt while making minimum payments on the rest.
If your household income is $3000 per month and you spend $1091 on your debt while paying about $1000 on regular expenses such as food, internet, clothing, subscription services, transportation, and utilities. You are leftover with roughly $909 per month. You can pay off your smallest debt of $700 and a small chunk of your second smallest debt of $2500 within 1 month.
Step 3: Repeat until your Debt is Gone.
With your credit card bill paid off, you are no longer spending the minimum payment of $25 per month. Now you can put that $25 towards paying off your second credit card. Once both credit cards are paid off, you now have $73 per month you can put towards your student loans. Once your student loan is paid off, you no longer have to pay the $178 minimum payment. Now you can put an additional $251 per month into paying off your car loan. This keeps going until you pay off all of your debt.
Why the Snowball Method Ignores Interest Rates
You may think it is smarter to pay off your highest interest debt first and not your lowest balance debt. If you are thinking that then you are correct. However the snowball method considers your psychology. If you pay off your smallest debt quickly, you will feel happy and motivated to pay off the next chunk of debt. My sister is using the snowball method to pay off her medical school student loans by paying off the smallest loans first. Every time one debt is paid off, she feels happy and less stressed.
The reason why the snowball method motivates you is because you can see your progress in paying off your debt sooner. With each debt gone, your minimum monthly payments decrease, allowing you to put that “extra” money towards other debt. It may not be the most cost efficient way of paying off your debt, but it is the easiest and least stressful way to do it. Having one chunk of debt is better than having four.
