Financial Sanity 101: The Debt Snowball
Now that you have your zero-based budget worked out, you’ve implemented the envelope system for your monthly cash expenditures, your four walls are covered, and you’ve saved up your baby emergency fund, you’re ready to get serious about paying down debt. The way we are going to do this is by using the extra money in your budget to create a debt snowball.
Here are the steps involved in doing the debt snowball:
- List your debts in order from smallest balance to largest.
- Pay minimum payments on all of the debts except the first one, upon which you should apply the snowball, aka all of the extra money in your budget you can come up with. If you’ve been adding money to the baby emergency fund, you’ll want to take that extra and now apply it to the debt snowball.
- As you pay off each debt, take the payment you’ve been making on that debt and apply it to the next on the list.
- Move on down the list, paying bigger and bigger amounts, until you are finally debt free.
So let’s do a really simple example here. Say we’ve listed our debts and we’ve managed to pay off our smallest debt, which is to Chase. Now we need to figure out what our new payment to Wells Fargo will be, based on the debt snowball:
|Creditor||Balance||Minimum Payment||New Payment|
Now you’ll be paying Wells Fargo $175, because that is the amount of the old payment to Chase (that you’ve paid off), and the minimum payment to Wells Fargo added together. When you pay off Wells Fargo, you proceed on down the list until everybody is paid off.
Common Objections to/Questions About the Debt Snowball
But, Anna? Wouldn’t you pay everything off faster if you did it by interest rate instead of by lowest balance?
In theory, yes. But the reason that Dave Ramsey advocates doing it this way, and why I also advocate it, is because there is a psychological boost that you get from paying a debt off in full that keeps you going, gives you a sense of accomplishment. If you go by interest rates, you are not going to get this boost. And the idea of this whole plan is to pay it off as quickly as possible, so the amount you are saving in interest is not significant enough to make that much of a difference in the final analysis.
But, Anna? Suze Orman says you should do it by interest rate. Don’t you think we should do it by interest rate?
Listen, if you want to do it by interest rate, that is fine by me. The objective here is simply to employ a debt snowball to get out of debt–I’m not concerned with the minutiae involved. I advocate smallest to largest because it is what worked for me, but as long as you are snowballing, then more power to you.
But, Anna? you say. We don’t have any extra money in our budgets! How are we supposed to get our snowball started?
Well, once the snowball gets moving, it will start to take on a life of its own. So to get it started, you may have to do something drastic, as I’ve advised many times before. You may have to take another job. Or throw your Christmas bonus at it. Or your tax return. You can try to avoid this kind of sacrifice as long as possible, but you really aren’t going to get anywhere until you just do it.
Questions? Concerns? Comments? Good luck!