MythTip: Building a Debt Snowball
If you’re looking to get out of debt, then you need a debt snowball. It is, in my opinion, the far and away best way to eliminate your debt.
What is a Debt Snowball?
Have you ever rolled a snowball down a hill? AS the snowball rolls down the hill, it grows larger. AS it grows larger, it rolls faster and faster until it becomes an immense force.
A debt snowball works the same way. You start with a small seed payment (which I call the snowball) that you use to pay off your debts early. The snowball grows and picks up momentum as time goes by until, before you know it, your debts are being paid off faster than you could ever have imagined.
How It Works
- List all your debts. Include the balance, interest rate, and minimum payment.
- Find some extra money for your snowball. The snowball doesn’t have to be huge to be effective. Even as much as $50 a month can make a huge difference. The larger your seed money, the faster your snowball will grow.
- Choose a debt to pay off first. Pay the minimum payment on all the other debts. Use your small snowball money to start paying down that debt until it is paid off completely.
- Take the minimum payment for the paid off debt and ADD IT TO YOUR SNOWBALL. Then use the new, improved, snowball as extra payments on the next debt.
- Repeat. Every time you pay off a debt, add it’s payment to your snowball, then attack the next debt in line.
There are many different ways to decide how to execute your debt snowball plan. The basic techniques are outlined below.
- Minimum Balance. In this approach, you pay off your debts in the order of their balance. The smallest debts are paid off first. The advantage here is that you get quick results. The small loans get paid off very quickly, so you get to build your snowball right away. This is the preferred snowball method of financial guru Dave Ramsey.
- Highest Interest Rate. This approach pays off debts in order of interest rate. The advantage here is that you get to get rid of the highest interest rate loans fastest. In theory, this would save you more interest in the long run.
- Balance/Payment Ratio. This last approach is a bit more complex. The order of repaying your debts under this method requires you to divide the balance of the loan by the minimum payment required. The debts are then repaid from lowest ratio to highest ratio. The logic here is that a low ratio indicates a small loan that is eating up more of your money than others. Therefore, low-ratio loans should both be quick to pay off, and give a big boost to your snowball right away. This is my personal favorite approach.
There is no universally right way to snowball. The best method will depend on your exact situation. These calculations are not particularly easy to perform. But that’s okay, because web developer Randy Merrill has created a powerful new web based snowball calculator that you can use to set up your own debt snowball. It’ll even let you choose your snowball technique and show you which works best. Check it out today!
Posted on 8 Dec 2011