Take a minute to think about a snowball formation. It starts with a little snow, which collects more snow, and builds up into something bigger.
And, that is how the snowball method of debt paydown works. You start with the smallest amount, then keep on building on to the higher ones. It may sound confusing at this point. But, read on to learn how to pay off debt fast with this method.
Understanding the Snowball Method of Debt Payment
Life typically comes with tons of bills, which you must pay. They could be the normal recurring monthly expenditure that includeS rent, fuel, groceries, and so on.
You may resort to borrowing money to supplement your income. It could be from family, friends, lending institutions, or credit cards. The fact is, you have to make payments to clear such amounts.
But, sometimes, you may not keep up, resulting in debts. It helps to find a way to clear such before the debt collectors come knocking.
The debt snowball method provides an effective way of dealing with such. It can especially be a useful method of how to pay off debt with low income.
Now, here is how it works. Please have a pen and paper nearby for this part.
- Write down all your debts. It doesn’t matter how small the amount. Have it on the list. If you have difficulties keeping track of your finances, consider using resources like Chuck Finance. You get an overview of all your finances in one central location. The platform offers analytics for insights into your expenses. It also gives tips on how to build healthy spending habits. They also send notifications and reports in easy-to-understand visuals.
- Now, lists the debts from the lowest to the highest amount. Do not include interest rates, just go with the balance.
- Allocate a minimum payment to each debt, taking into consideration how much you have
- Take note of any extra amount after completing the step above
- Take that extra cash and allocate it to the smallest debt. You are now in the initial stages of forming your snowball.
- Do this every month, until you finish paying off the smallest amount.
- Now, move on to the next, smallest debt.
- Put the money you used to pay towards the smallest amount and any extra to this debt. At this point, your snowball is getting bigger. Much like it would, if gathering snow as it rolls down the hill. Remember, discipline is key here. Every time you free up any money after wiping out debt, you allocate it to the next smallest one.
- Continue to do this until you clear up your debts.
Snowballs vs. Avalanche Method of Debt Repayment
On the other end of the spectrum is the avalanche method of debt repayment. In this case, you start with the highest amount and move on to the smaller one. And, many would argue that it makes a lot of sense.
But, there is one thing that they may not factor in. The snowball method provides a lot of motivation. Every time you tick off debt, no matter how small, it provides an impetus to keep up with the progress.
This debt reduction strategy can also reduce financial stress. You focus on clearing one debt at a time, thus a little more breathing space.
The avalanche method requires discipline and access to constant discretionary income. You may save on high-interest rate debts by getting them out of the way sooner.
But, it will take longer to wipe out the debts, which can put a damper on your efforts. Truth is, if you don’t see much progress, you are more likely to give up.
There are instances when the avalanche method will work though. It is the best way to pay off credit card debt if you have multiple cards. Getting rid of high-interest rate balances first can save you tons of cash in the long run.
Is There a Downside to the Snowball Method of Debt Paydown?
The snowball method is a play on human psychology. Small wins bring gratification and a feeling of achievement. The feeling gets better when you cross out the debt with a red marker pen.
With that said, it would be remiss of us not to mention a downside or two of the snowball method. If you remember, we pointed out that you concentrate on the balance, and not interest rates. So, let’s give a real scenario for a better understanding.
Let’s imagine the following expenses.
- Credit card debt -$5,000 at 18% interest
- Car loan – $10,000 with 3% interest
- Hospital loan – $12,000 at 2% interest
- Student loan – $20,000 at 5% interest
With the snowball method, you would start with the credit card debt of $5,000. That means you ignore the hospital bill with the lowest interest rate. In the end, you will pay more in interest for the car. This makes the snowball method a little more expensive in the long run.
The second downside is the amount of discipline you must have. It can be tempting to divert the freed-up cash to other projects.
The debt snowball method helps pay off debt fast. Like any other debt reduction strategy, it requires discipline.
List down all your debts. Allocate minimum payments to each. Any extra cash goes to clearing off the smallest debts. Once you finish it off, roll over the amount and any extra to the next one.
A lingering question may be, which is a better option between snowball and avalanche debt repayment methods? Well, giving a clear-cut answer may be a bit difficult. It all comes back to you.
Start by taking stock of your financial situation. If you can afford to pay off high-interest-rate debts first, then by all means do so. The savings will be worth the effort in the long run.
But, if you are someone who needs that constant boost or motivation, then snowball will work well. At the end of the day, what you should aim to achieve is a debt-free existence.