The Snowball Debt Reduction Strategy
Many people, who want to become debt free, use the snowball debt reduction strategy. First, I’ll explain what you need to do, and then explain why the snowball method works so well.
The idea is to pay off your smallest debt first, then the next smallest, then the next smallest…and so on. Until you become debt free. You can use the debt snowball reduction strategy with any number of debts and any size of debt. But let’s start with a simple example.
The Debt Snowball Method
Say you owe a total of $9,000 split between the following debts:
- $5,000 Credit Card A (monthly interest rate 2%)
- $1,000 Credit Card B (monthly interest rate 0%)
- £3,000 Auto/car Loan (monthly interest rate 1%)
The snowball debt reduction strategy step-by-step:
- You list each debt but in order of size of debt, the smallest at the top. So, this would be Card B, then the auto loan, then Card A.
- Make the monthly minimum payments against each of your debts, except the smallest.
- Every month, pay off as much as possible from the smallest debt (at least the monthly minimum, but ideally more).
- Once you’ve paid off your smallest debt, go back to your list and strikethrough that debt. Progress! (Hopefully, that will bring a good feeling).
- Then move onto the next smallest debt pay and pay as much as possible off that one, month by month until it’s gone. Strikethrough it on the list.
- Until, finally, you tackle your largest debt (which will be the only debt remaining). Pay than one off in the same way.
- Celebrate becoming debt free!
So, in the example figures above, the snowball method of debt reduction directs you to pay off the $1,000 first, even though it is at 0% interest. Then you move on to the auto loan, and finally the biggest debt, Card A $5,000.
In addition to the snowball debt actions, you will improve your chance of becoming debt free if you take these extra steps:
- Before you start paying down your debts, build an ‘emergency fund’ of at least $500 in a separate instant-access bank account (or in cash).
- Stop buying anything on credit and don’t take out any other forms of personal loan. There’s no point paying off your existing loans with one hand, and taking on more debt with the other. If you’ve built your emergency fund, you are less likely to reach for your credit card to pay unexpected bills that crop up.
- Every month, create a budget for the following month. Use the budget to plan how to free up money to build your emergency fund and then to tackle your smallest debt.
Debt snowball isn’t the only method for becoming debt free. But it has one major advantage: its psychology.
Why the Snowball Debt Reduction Strategy is Popular
It works! And when it comes to personal budgeting, finding a method that works for you is what counts. Debt snowball is a new habit. Instilling new habits is always a challenge. But this is a challenge you can overcome, provided you have sufficient income to make extra payments against your debts each month.
The snowball debt reduction strategy is designed to help you form these new money management methods. Here are some key points:
A clear plan. Often people fail to take action – like paying off debts - because it all seems too complicated. But if you have a step by step plan to follow – one you know has worked for other people – it can give you the confidence to get started. Debt snowball is like a tried and trusted road map.
Simplicity. You don’t need to look at the interest rates charged on each debt. You just list out the balances, smallest to biggest. Then tackle the smallest.
Quick progress. By paying off the smallest debt first, you’ll be striking through the first item on your list quickly. And when you first start out with debt snowball, paying off the smallest debt can feel more manageable than tackling a bigger debt.
Self-belief. When you strike though that first debt – when you’ve paid it off – it can help build your confidence. You’re on track. Just keep it going. This is working.
Momentum. This is not unique to the snowball debt reduction strategy, but is important. Once you’ve paid off one debt, you free up the money you were using to service that debt. As you work through your list to the bigger debts, you will hopefully be able to make bigger and bigger repayments each month.
Alternative Debt Repayment Strategies
Going back to our example, is it really logical to pay off the $1,000 debt first? Would it not be cheaper in the long run to start with the most expensive debt, the one with the highest interest charge?
Yes, it would be cheaper. Paying the higher interest debt first is called the debt avalanche strategy. For some people debt avalanche is the best route. But when the highest interest debt is one of the biggest on your list, it can take a long time to pay it off. So, you don’t get to strike a debt off your list as early as if you were following the snowball debt reduction strategy.
Yes, it does make ‘sense’ to pay down higher interest debt first. For that reason, some people prefer the debt avalanche method for debt.
However, when it comes to human psychology, ‘sense’ and logic are not necessarily the most important factors. What really matters when it comes to becoming debt free is the actions you take month by month.