How does the debt snowball method work?
The debt snowball method does the following:
- Make the minimum payment on all five debts.
- Put extra money in debt A.
- Pay off debt A. Put all of the money you spent on debt A in debt B.
- Pay off debt B. Put all of the money you spent on debt B in debt C.
- Pay off debt C. Put all of the money you spent on debt C in debt D.
- Pay off debt D. Put all of the money you spent on debt D into debt E.
- Pay Off Debt E. You Are Now Debt Free!
In this scenario, you are wagering $ 510 per month on the minimum monthly payments. Let’s say you have enough cash to meet all of your minimum requirements plus an additional $ 50 per month.
For the first two months, you would pay a total of $ 75 in debt A. (The minimum payment of $ 25 plus the additional $ 50.) In just two months, you will have paid off Debt A in full.
Next, put the $ 75 you paid to Debt A to Debt B. Your total monthly payment for Debt B is: $ 35 + $ 75 = $ 110. (The minimum payment for debt B, plus the money you wagered on debt A.)
If you pay off Debt B, that $ 110 will be transferred to Debt C. When you pay off debt C, you can put $ 310 on debt D. When you get to Debt E, you can make $ 560 monthly payments. (That’s the money from all minimum payments plus the additional $ 50.)
Why the debt snowball method works
The snowball method is a debt settlement plan that relies on the power of motivation. By focusing on your smallest debts first, you can pay them off quickly. Instead of spending years making slow progress on large debts, you are making a quick profit.
This progress gives you a sense of achievement that can motivate you to keep going.
When you settle each debt, carry over the payments onto the next. As the balances grow, so do the payments. This will help you keep your momentum going; You will always see progress. If you reach your greatest debt, now it is yours only Blame. This can make it a lot less intimidating.
The trouble with the debt snowball
While the debt snowball method can be great for some people, it has one major drawback: it is expensive. That’s because it basically ignores your interest rates.
The longer you have a particular debt, the more interest you pay. High-yield debt, like credit card debt, can incur many fees over time. If your biggest debt is also your debt with the highest interest rate, you could be paying thousands in interest fees to the point of debt free.
This additional interest also means it will take you longer to pay off all of your debts. Each minimum payment is first used to pay the interest fee. Only when the interest fees have been covered will the remainder be added to your main balance.
One way to limit this problem is to lower the credit card interest rate. The best way to do this is with a credit transfer credit card. This allows you to transfer a credit card balance to a card with a lower APR, reducing your interest fees. (Check out the balance transfer calculator to see how it works.)
The debt snowball method vs. the debt avalanche method
If you are interested in paying off debt as quickly as possible, the debt snowball method may not be for you. Instead, you may prefer the debt avalanche method.
With the debt avalanche method, you prioritize your debts by interest rate. Instead of focusing on the smallest debt first, focus on the one with the highest interest rate. When you settle that debt, you go to the debt with the second highest interest rate – and so on.
Because you pay off your most expensive loans first, you pay less overall interest. You will also get out of debt faster if you don’t have to pay additional interest. (You can use a credit card interest calculator to get an idea of how interest rates can affect debt payments.)
Both methods have their own advantages and disadvantages. If you are someone who needs a win to stay motivated, the snowball method can work best. However, if motivation is not a problem, the avalanche method can save you money.