Getting out of debt with the Debt Snowball Method

The Debt Snowball is a way of avoiding bankruptcy by paying off your debts in a deliberate, strategized stepwise manner. Many people ask the question, How do I know how much debt I have? Well one way is to apply the Debt Snowball Calculator which helps to outline and prioritize the debts. The methods proponents include Dave Ramsey and other financial experts. Read on to see a practical application of the method

When we get into a debt crisis, it seems there is no way out except to borrow more. The greatest drawback is that while you get temporary relief from your howling creditors, the credit rates get higher based on the amount of debt you already carry. Loan Consolidation is another method that gives you temporary relief but does not give you the euphoria of victory that comes from paying off debts. The basis of the Debt snowball effect is reducing revolving debts by applying small amounts of extra cash to the smallest debts you owe. It works best for those who see the debts as a challenge and are willing to continue even as the smaller debts get paid off.With this method avoid taking on new debt.

I will list the steps first then give a practical example after it.

Step 1 - Make a list of all the amounts you owe arranging them in ascending order. The smallest debts will at the top.

Step 2 - Resolve to pay off the smallest debts with a certain determined sum in addition to what you pay every month to service the debt.

Step 3 - Once you have paid off that debt, target the next on the list. Add the value of the first debt plus the extra money you devoted to pay it off. Pay this as an additional towards the next debt. The next step is the most important.

Step 4 - Repeat these steps until the debts are gone.

The snowball arises from the fact that the amounts paid towards debt relief get progressively larger as you continue ensuring that even the bigger debts get paid off in a shorter time.

Now for an example

Suppose you have the following debts with the corresponding minimum monthly payment, the debt snowball method will work this way.

1.     Card Debts - $500 balance - $40/month minimum
2.     Furniture Payments - $500 balance - $50/month minimum
3.     Auto Loan - $3000 balance - $200/month minimum
4.     Other Loan - $10000 balance - $350/month minimum

Step two – You resolve to pay an additional $100 a month to become debt free.

The first month you pay

1.     Card Debts - $500 balance - $40/month minimum plus $100
2.     Furniture Payments - $500 balance - $50/month minimum
3.     Auto Loan - $3000 balance - $200/month minimum
4.     Other Loan - $10000 balance - $350/month minimum

While it would have taken you 12 and half months to pay off the card debt, using this method, in four months you’ll eliminate it. Meanwhile your monthly payments will now look like this’

1.     Furniture Payments - $300balance - $50/month minimum plus $140
2.     Auto Loan - $2,200 balance - $200/month minimum
3.     Other Loan - $8,600 balance - $350/month minimum

This is the snowball effect which can only happen if you are disciplined enough not to spend the $140 or get into fresh debt.

In three months’ time, the second debt is paid off and you have $340 to apply to the third debt, which by that time is $1,600.

1. Auto Loan - $1,600 balance - $200/month minimum plus $340
2. Other Loan - $7,550 balance - $350/month minimum

In another three months, the auto loan is gone and you are left with just one debt of $6500 to which you pay $890 a month. This will take only 8 months to pay off.

Comparing with you initial plan in which you would have been debt free in 30 months, the debts are all gone in 18 months.

The most difficult part of using the debt snowball method is that it flies in the face of head knowledge which tells you to pay off the debts with higher interest first. Although this makes financial sense, nothing beats the invigorating effects of crossing off debts. The knowledge that you are getting out of a debt crisis and are once more in charge of your personal finances is one of the best motivators to continue. As I said earlier, the Debt Snowball effect only works for those who allow the ball (repayment amount) to gather snow (get larger). Once you treat the money as yours to spend or take on additional debt, you lose momentum and the method fails.