How Does the Debt Snowball Work?

Do you have several debts that you’d like to pay off, but don’t know where to start? Are you looking for an effective yet simple way to work through them one by one until they’re all gone? If so, then what you need is a payoff strategy like the debt snowball method. 

Chances are you’ve probably heard the debt snowball mentioned in podcasts or other media. But what is it exactly? In this post, I’ll explain how the debt snowball method works and why it has helped so many people to fix their issues with money.

What is the Debt Snowball Method?

The debt snowball method is a debt-reduction strategy where you systematically pay them down from the smallest to largest balance. As each debt gets paid off, you add the previous payment on top of the next one. With each new cycle, your timeline will accelerate because you’ll make bigger and bigger payments (kind of like a snowball that gets larger the more it rolls along).

Debt Snowball Example

Let’s say you’ve got three outstanding debts:

  • An auto loan with a balance of $10,000 and a 4.0 percent APR
  • A student loan with a balance of $20,000 and a 10.0 percent APR
  • A credit card with a balance of $25,000 and a 20.0 percent APR

Step 1 – Put the Debts in Order

The first step is to organize your debts by the size of their balance. In this scenario, the priority would go: auto loan, student loan, and then the credit card.

If you were wondering how the interest rate has an effect, it doesn’t. The debt snowball method doesn’t consider the interest rate, so you can ignore it.

Step 2 – Pay Off Debt #1

Next, we’ll start making payments. Since the auto loan has the smallest balance, this is where you’ll begin. Make just the minimum required payment on the higher balance debts (your student loan and credit card). This will allow you to put all of your financial resources into putting as much money as you can towards paying down the auto loan as quickly as possible. 

Step 3 – Pay Off Debt #2

Once the auto loan is fully repaid, your focus should turn to the debt with the second-highest balance. In this case, this will be the student loan.

Now comes the beauty of the debt snowball method. Even though the auto loan is paid off, take the amount you were paying towards it and add it on top of whatever you can towards the student loan. 

For example, in step 2, you might have been paying $600 towards your auto loan and $400 towards the student loan. According to the debt snowball method, in step 3, you’d now combine them together for a total of $1,000 towards the student loan each month.

Continue to only pay the minimum amount on the credit card.

Step 4 – Pay Off Debt #3

Once the student loan is paid off, we’ll begin the cycle again. Your last remaining debt is the credit card. Not only will you pay off the minimum amount, but you’ll also add in the $1,000 you were paying in step 3 on top of it. Now you’re putting everything you’ve got into this debt, and that should help you to eliminate it as quickly as possible.

Why Should I Use the Debt Snowball Method?

As you could probably tell from the example, there are a lot of benefits to using the debt snowball method.

It’s Very Systematic

The debt snowball method is simple to use. There’s no math or help needed from a financial professional. You simply put the debts in order and then knock them out one by one.

Your Payments Will Be Accelerated

If you can stay disciplined to the method and continue to roll your payments from one debt to the next, then they will grow with time. This is not only a simple process to follow, but it’s a great way to gain momentum along the way.

Immediate Gratification 

Perhaps the greatest benefit of the debt snowball method is the psychology behind it. This strategy works because you’ll have more “tiny victories” early on. Since you purposely go after the smallest debts by design, you’ll have the best chances of paying them down. That will make you feel successful and motivate you to stick with the process. 

How Does the Debt Snowball Method Compare to the Debt Avalanche Method?

The debt avalanche method is another debt reduction strategy that emphasizes interest rates instead of balance. It follows a similar sequence of steps where you put the debts in order from largest to smallest interest rate and then work through them one by one. In our example, this would go: Credit card, student loan, and then auto loan.

Mathematically, the debt avalanche method is actually better. By eliminating high-interest debt first, you’ll ultimately pay less interest over the life of the process than you would with the debt snowball method. 

However, it may not be as mentally satisfying. As is the case in our example, the debt with the highest interest rate also happens to the one with the greatest interest rate. It may take years before this debt is paid off in full. Since you won’t feel as victorious, you might be more likely to become discouraged or even give up than you would if you were using the debt snowball method instead.

The Key to Success

No matter if you decide to use the debt snowball method or some other type of pay-down strategy, the main thing you can do to ensure your victory will be to free up as much money as possible to put towards your debts. The best way to do this will be to mind your budget and try to reduce as much unnecessary spending as possible.

If you’re having trouble trying to identify where to cut the spending fat, a budgeting app like Buxfer can help you to do this. Buxfer lets you tag expenditures so that they will be easily categorized and tagged in real-time. That enables you to see which expenses are your top movers and where you might have some work to do. To find out more about how Buxfer can provide you with insights, click here.

Remember: When it comes to budgeting, it’s all a question of priorities. Ask yourself: Which would I rather have – this thing I want, or the opportunity to reach financial freedom?

Image credit: Pexels

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