Debt Snowball
Definition:
The debt snowball method is a debt repayment strategy that focuses on paying off debts from smallest to largest balance, regardless of the interest rate. This approach aims to build momentum and motivation as smaller debts are paid off quickly, creating a "snowball effect" that helps tackle larger debts over time.
How It Works:
List Debts by Balance:
Arrange all debts in ascending order based on their outstanding balances.Make Minimum Payments:
Pay the minimum payment on all debts except the smallest one.Focus on the Smallest Debt:
Put any extra money available toward the smallest debt to pay it off as quickly as possible.Repeat for the Next Smallest Debt:
Once the smallest debt is fully paid off, take the amount previously allocated to that debt and apply it to the next smallest debt. Continue making minimum payments on the rest.Continue Until All Debts Are Paid:
Repeat the process until every debt is paid in full.
Example:
Assume you have three debts:
Credit card debt: $1,000 at 18% interest
Medical bill: $500 at 0% interest
Car loan: $5,000 at 4% interest
Step-by-Step Plan:
Pay minimums on the credit card and car loan.
Allocate all extra funds to pay off the $500 medical bill first.
After the medical bill is paid, use the freed-up $500 payment toward the credit card debt.
Once the credit card is paid off, focus on the car loan.
Pros:
Builds motivation by providing small, quick wins.
Helps maintain focus and consistency in debt repayment.
Simple to understand and implement.
Cons:
May result in paying more interest over time compared to other methods (e.g., the debt avalanche method).
Does not prioritize debts with the highest interest rates, which could delay financial progress.
Who Should Use It:
The debt snowball method is best for individuals who need psychological motivation to stay committed to debt repayment. It works well for those who benefit from celebrating small victories along the way.
Comparison to Debt Avalanche:
Debt Snowball: Focuses on balance size; ideal for motivation.
Debt Avalanche: Focuses on interest rates; ideal for saving money on interest.
By providing structure and clarity to debt repayment, the debt snowball method can help individuals regain control of their finances while building positive habits.