The term “debt snowball” could describe how debt builds up; a little bit becomes a little more and soon it’s rolling downhill, out of control and growing as it goes. However, it actually refers to a debt repayment strategy championed by financial guru Dave Ramsey. This method focuses on paying off the debts with the smallest amount first instead of highest-interest debt approach. Its advantage lies in the positive feedback and building confidence as each progressively larger debt is tackled.
To get the ball rolling, list all of your debts in order from largest to smallest. You will need to prepare a budget, but this is advisable for anyone who wants to get out of debt or just manage money well. Once you know how much money is coming in and going out, you can find room in the budget for debt repayment. Commit to making the minimum payment on every debt so you don’t fall behind and devote any extra amount you can toward the smallest debt. Once the first debt is paid in full, congratulate yourself on the first step towards financial independence and start on the next debt. Since you no longer make payments on the first debt, you can add that amount to the payment you were already making. Keep a chart somewhere very visible, like the front of the refrigerator or on display in the family room, where you can see how far you’ve come and track your progress on your current debt focus. As you pay off each debt, you’ll see how the amounts you can afford to devote to debt repayment rises as each smaller debt is wiped out and the amount of its payment rolls over to the next. The key to the snowball method is to watch your progress, build your confidence and maintain your motivation to stick to your repayment efforts.
A secondary benefit of this method is that the overall amount you owe to creditors each month is minimized, since as you progress you have fewer payments to make. In the event of a job loss, medical emergency, natural disaster or other financial catastrophe, you can still make minimum payments and avoid falling behind on debts and potentially incurring fees and penalties.
Here’s the fine print: this method only works if you can make the minimum payment on all debts. If you can’t, you are better off prioritizing your payments, taking care of yourself and your family first with housing and utility bills, until you can start making payments on all debts. You’ll need to know the terms on your loans before you start, because some loans incorporate an early repayment penalty. Some lenders, often for mortgages and car loans, will apply extra payments toward the next payment, which won’t help you pay off the debt any sooner. Instead, you must contact the lender directly and specify that the payment should be applied toward the principal of the loan.
If you have strong financial self-discipline, stick to a budget like gum to the underside of a desk and have calculated your repayment plan to eliminate debt as quickly as possible, you should pay off the highest-interest debt first. The math is on your side. However, the debt snowball provides incentives and progress checks, keeping the ball rolling on your road to a debt-free life.