debt

# What is a debt snowball?

For many people, the thought of eliminating debt is a dream they cannot imagine turning into a eality because it can take years to achieve. Yet, paying off debt and paying off credit cards reduces debt to income ratios, improves credit scores and increases disposable income.

The debt snowball method is a debt reduction strategy designed to keep people motivated as they pay off debts. Here's how it works.

## Debt snowball basics

Individuals who use the debt snowball method start by listing all their debts from smallest to largest, without regard for the interest rate on the account. This list may look something like this:

• Credit card 1: \$700 (\$35 minimum).
• Credit card 2: \$2,500 (\$75 minimum).
• Car: \$7,000 (\$250).
• Student loan: \$25,000 (\$250).
• House: \$110,000 (\$600).

Following the debt snowball method, this person pays the minimum payment on all the bills, except the smallest. Any extra money -- obtained through a second job or by cutting out an item on the budget or a gift -- goes toward the smallest debt (credit card No. 1) until the balance reaches zero.

After paying off the debt, this person starts focusing on the next smallest debt on the list, paying all available money, including the minimum payments originally paid on the paid-off debt, and repeats the same process until the second debt disappears.

## How the debt snowball works

Creating and following a budget is an essential part of making the debt snowball work. The budget shows where money goes each month and how much is available for paying down the debt. Imagine that the person in the previous example brings home \$1,700 each month and has the following budget:

• Mortgage: \$600
• Car: \$250
• Utilities: \$100
• Phone: \$100
• Food: \$250
• Entertainment: \$50
• Gas: \$100
• Car insurance: \$100

This person already has \$150 each month available for the debt snowball, without changing any of the budget categories.

With the debt snowball method, this individual pays the \$75 minimum payment to credit card No. 2 and puts the rest toward credit card No. 1. In 10 months, credit card No. 1 will have a zero balance and that person will then start paying the entire \$150 on credit card No. 2's balance.

To speed up this process, this person can first look to the budget and eliminate categories or reduce the amount allotted to them. For example, instead of spending \$50 each month on entertainment, this person can put it toward credit card No. 1's balance and pay it off in six months.

## Advantages of the debt snowball method

Proponents of the debt snowball method point out that its greatest advantage is the psychological boost it gives people. First, since they pay off the smallest debts first, they get to see separate debts paid in full sooner. This is especially significant for people who carry significant amounts of debt or struggle under the weight of paying bills each month.

The debt snowball also helps budgeters focus all their energy on a single debt instead of watching all of them at the same time. This eases some of the stress of carrying debt so they stay motivated during the process.

## Disadvantages of the debt snowball method

Opponents of the debt snowball method argue that it fails to consider the amount of money individuals save by paying off higher interest accounts first. To them, it makes sense mathematically to pay off higher interest accounts -- called the avalanche method -- so they don't continue accruing interest.

Others have concerns about devoting all available cash reserves to paying off debt, which they see as risky. An emergency has the ability not only to wipe out the progress toward eliminating the debt, but it creates additional debt.

## Conclusion

Getting out of debt is not an easy process. It requires discipline, determination and dedication to creating a plan of action and turning it into a reality.

The debt snowball method is an easy-to-follow plan designed to help people pay off their debt as quickly as possible, and maintain a sense of momentum during the process. To compare this technique with others like the avalanche method, check out a loan repayment calculator to see how much time and money it saves.

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