Posted June 2020
Get on a roll with this super effective debt repayment strategy...
When it comes to personal finances, getting out of debt is a top priority.
But working out how you’re going to tackle your debts can feel overwhelming!
If you’re not sure where to start, the debt snowball method could be the perfect way to help you get out of debt faster. Not only is this strategy simple to master, it’s also really motivating to see your debts diminishing so quickly.
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:
- What is the debt snowball method and how does it work?
- Start snowballing your debts with these 6 steps
- Example: The debt snowball method in action
- How best to leverage the debt snowball for you
- What about debt consolidation?
- What about the debt avalanche 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
Snowballing your debts is super easy! Here’s how:
- 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.
Example: The debt snowball method in action
Let’s look at a real life example to see just how this works.
First, 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 would 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!
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.
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 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.
What about debt consolidation?
Debt Consolidation sees you rolling all of your debts into one easy-to-manage loan.
Consolidating your debts leaves you with just one repayment date to focus on, so you're less likely to miss a payment. Securing one loan at a lower interest rate will also help pay off debt sooner.
To avoid inadvertently taking on additional debt through higher interest, it’s best to seek a consolidation strategy through a financial provider like a credit union that will counsel you through the process and help you secure a great rate.
What about the debt avalanche method?
A debt avalanche - also referred to as debt stacking - is an alternative approach where you focus on the debt with the highest interest first, rather than the debt with the lowest balance.
Which one is right for you depends on your financial situation, as well as how well you know yourself. If you’re more disciplined with your finances? You may want to consider the debt avalanche approach.
If you require more motivation, experts such as Dave Ramsey - who popularised the debt snowball method - say that while avalanching your debts can be effective, personal finance is “20% knowledge and 80% behaviour...” so the quick-wins of snowballing may be more motivating.
It's time to melt your debts away
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 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 the debt snowball method, you’ll quickly melt your debts away!