The first time I heard the term “debt snowball” I thought it meant the horrible problem of debt growing bigger and bigger and careening out of control. But, in fact, I found out that it’s quite the opposite. As you may already know, the debt snowball is the process of reducing that out-of-control debt in a methodical way that continues to gain momentum – yes, like a snowball rolling down a hill.
Why Use The Debt Snowball Method
The debt snowball is a method for paying down any debt, not just credit cards, and it’s extremely easy to implement. By tapping into this method, the debt snowball can save you thousands of dollars in interest payments and significantly (by years) reduce the time it takes to get you out of debt.
How To Get Started
- Make a list of all of your credit card debts (you can include other debts as well, such as school loans, auto loans, and home equity loans).
- For each loan, list the creditor, the outstanding balance, the monthly minimum payment, and the interest rate.
- Add up all the minimum monthly payments due, and continue to pay at least this amount until all of your debts are paid in full.
- As your balance goes down, so will the minimum payment, but continue to apply the higher amount to the accounts each and every month. When you pay off the card with the highest interest, take the amount you were paying on that card and put it toward the card with the next highest interest rate and so forth.
- Pump it up! When you have extra money (tax return, rebate from your new phone, etc.), apply it to your highest interest rate card. These extra payments result in great savings for you.
Why Pay Down the Highest Interest First (and not the lowest balance)
There are two schools of thought on how to approach paying off your credit card debt using the Debt Snowball.
- Pay off the smaller ones first and work up to the bigger ones.
- Pay off the higher interest rate cards first and work down to the lower ones
Think Bigger and Bigger vs. Faster and Faster
Attacking the cards with the highest interest first makes the most sense. Your savings will be greater and the time to pay off the total debt will be significantly less– effectively reducing the total amount of debt in a shorter amount of time.
If you approach the smallest debts first, without concern for the interest rates, you can still get to your goal, but it will take you longer and cost you money. The psychological benefit of the quick payoffs might be the key for many people but consider this; the need for “instant gratification” is what got you in this fix in the first place. Once the small accounts are paid off and the big ones are still looming ahead, it may become disheartening for you and the positive (and small) initial boost will be a dim memory.
Better Credit = Less Interest = More Savings
But wait, there’s still another way to save — an added bonus to the effectiveness of the debt snowball plan is your improved credit standing. As you start paying down your balances, your payment history will improve and your credit score will begin to go up. Take this opportunity to contact your credit card companies and ask to have your interest rate reduced. Often it can be as simple as a phone call. With auto loans and home equity loans, it will likely require a refinance, but the savings can be substantial. Again, keep paying the amount you were paying before the interest was reduced for some serious momentum.
How to Avoid the Pitfalls
As straight forward as this debt repayment method is, you need to be prepared for some temptations and some pitfalls. These are a few of the biggies.
- Watch out for more debt. When you start to get some breathing room, don’t take this as the go ahead for more spending. While expenses (and impulses) are sometimes unexpected, do everything in your power to avoid new debt.
- Have an emergency fund. Start by setting money aside for the unexpected. Even a small cushion of money will help you avoid more debt in a crisis.
- Don’t get discouraged. Whether you are motivated mathematically or psychologically, consider the end result (most money saved) and pick the approach that will sustain your efforts and get the (snow)ball rolling.
The whole idea is to get you out of debt and save you money. We’re talking your personal finances here! Review your accounts, use the debt reduction calculator provided at CNN.com and see how long it will take you to roll yourself out of debt, and how much you will save by paying off your high interest cards first.
Photo Credit: lemonjenny via Flickr