The Debt Snowball method is one of the three most popular methods of debt reduction, often compared to the other two alternatives, namely the highest interest rate first and the debt tsunami method.
Proposed by financial advisor and host Dave Ramsey, the debt snowball is an approach to paying off debt wherein the smallest debts are paid first before larger debts, regardless of the interest rate. The method is named as such in comparison to a snowball. A small ball of snow may actually seem negligible at first, but if you let it roll downhill, it takes in more snow, until it gets bigger and bigger and unstoppable.
1. The first step in the debt snowball is to list down all of your debts in the order of the smallest to the highest debt, regardless of the interest rate. In the event that two debts have exactly the same or close amounts, only then should you prioritize the one with the higher interest rate.
2. Next, you should determine the minimum payments required in each debt. List them down alongside each debt.
3. Devise a budget plan. Make necessary adjustments to accommodate payments for each debt’s minimum amount. Then take extra measures to spare a little more extra cash that should go towards paying off the smallest debt.
4. Pay all of the minimum amounts while adding the extra cash to the smallest debt. Do this every time until the smallest debt is paid off.
5. Take the previous amount used in paying off the smallest debt (the minimum amount plus any extra) and add it to the minimum amount for the second smallest debt. This time, you’ll have a larger amount for payment since the first one is cleared.
6. Repeat the process until all debts are paid in full.
Just like a small clump of snow, your efforts in the beginning may seem too small to be noticed. However, as you go along, you’ll find that the pot of money that goes towards paying off the larger debts becomes bigger and bigger, just like a snowball.
The method is often compared to the highest interest rate approach, which has the exact opposite principle. Supporters of the highest interest rate often dispute the snowball, mainly because they believe that this method carries a higher cost to the payer. By delaying payment of debts with the higher interests, you would spend more in the process unlike if you get rid of them first.
However, Ramsey firmly believes in the psychological benefit of the debt snowball, and says that âpersonal finance is 20% head knowledge and 80% behaviorâ. With the debt snowball, people can gain quick wins in seeing immediate results. This in turn can give them the boost to stay focused on their debt reduction goal.
There are really some people who need to be psychologically motivated in order to stick to a long- term task, and for these people, the debt snowball may actually be the answer that they are looking for.