The first time you hear “debt snowball,” you’re likely to wonder: What is it? I will tell you…
Did you ever see How the Grinch Stole Christmas — the classic cartoon version? And do you remember how the little dog-reindeer got stuck in a snowball that careened down the hill and got bigger as it went along?
That’s the same idea behind a debt snowball. The more balances you pay off completely, the more money you’ll have available to pay off each successive balance.
Debt Snowball Explained
Let’s say that you have five different balances that you want to pay off. Naturally, each balance is being charged a different interest rate. And you will owe a different amount of money on each balance.
Here’s what you should not do:
If you have $100 extra to put toward your debt each month, you should not divide the money equally and pay down each of your five balances by $20 each.
This may feel good because each balance is decreasing — but it’s definitely not the most effective way of paying off your debt.
But which balance do you attack first? That’s the question.
How to Decide Which Debt to Pay Off First
Usually, you will want to pay off the smallest balance with the highest interest rate. If your smallest balance does indeed have the highest interest rate, it’s a no-brainer. You pay off that balance first.
Then, after it’s paid off, you take what you HAD been paying toward that debt — add it to your debt snowball — and start throwing it at the next balance in line. Here’s a brief example:
Watch Your Debt Snowball Grow!
Extra Money to Pay Off Debt = $100
Debt #1: Minimum Payment = $50
Debt #2: Minimum Payment = $125
In this short example, you pay $150 toward Debt #1 until it is paid off. You then take this amount and add it to the minimum payment of Debt #2. So $150 + $125 = $275.
You now have $275 per month to put toward Debt #2. As you can imagine, you will pay off this debt even faster than you paid off your first balance because your debt snowball is now much bigger.
Imagine how big it will be by the time you get to the fifth and final balance!
Debt Snowball: Better than Consolidation?
Some will tell you that it’s actually more effective and less expensive to use the debt snowball method to pay off your debts.
This is because consolidating debt often has some costs associated with it: balance transfer fees, management company fees, etc.
If you can manage your own finances, and start your own debt snowball program, you may be able to reduce your debt — and ultimately become debt free — faster than you might imagine.
So what’s next?
You might consider searching Google for a debt snowball calculator. There are some free calculators out there that can help you figure out what order in which to pay off your debts.