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It can be challenging to take care of if you have several loans to pay. No matter where those loans come from, it gets hard for anyone. It gets even worse if you have a stringent budget and see all of your money going to debt.
A majority of Americans have a plan to reduce their personal debts within specific timelines, based on a poll conducted by Northwestern Mutual.
The snowball method is already being used to give people more momentum when making those payments. Getting started takes time and effort, but it’s often effective. It can be the motivation needed for someone to pay off their financial problems.
What Is The Snowball Method?
When we talk about this method we’re talking about paying the smallest debt first. No matter what the interest is, the smallest balance goes right off. Once it’s paid you start making that payment added to the payment on the second smallest debt. You start slowly working your way up.
And each one should add on the payment of the one before it. Because debts disappear faster it provides more motivation and sense of achievement.
The momentum it provides gives you the push to keep going. Psychologically and even emotionally, this type of debt repayment can be the right way to go. It may cost more in interest than other methods, but it keeps you moving.
Debt Snowball Method: Example
What you’re going to do is rank your debts from smallest to largest. From there, pay only the minimum on each account. Pay anything extra that you might have to the smallest loan. From there, start working your way slowly up the list.
Let’s take a look at a situation to use as an example. If you have 4 different debts, at $500, $200, $400 and $100 you want to put them in order.
You’ll want to order them like this:
- $100 ($15 minimum payment)
- $200 ($20 minimum payment)
- $400 ($20 minimum payment)
- $500 ($30 minimum payment)
If your total available money is $120 you need to first make the minimum payment on each account. That means you put $85 toward your debt. It leaves you $35 of extra money. That means you would put that extra $35 with the $15 you need for debt 1.
Once the first debt is paid off (in month 2) you’ll put all that money ($60) toward debt 2. Then you move your way up and up until you get rid of each debt. Keep going all the way through the final debt on the list.
$50 (paid off)
$20 (paid off)
Benefits of Using The Debt Snowball Method
What you need to know about this method is that it’s going to make you more confident. You’re going to feel more motivated because you’re seeing some results. That’s going to keep you moving along as well.
When you get rid of that first debt, you’re going to feel great. It just makes sense that you would, right? You’ll be amazed that you no longer have that debt and can move on. As you get rid of one debt after another, you’ll feel more like you can get things done for the other debts.
When you start pushing a little harder you find a little extra money. You work a little extra or a little harder. You’ll start thinking twice about spending money in a number of different ways. And that’s going to make a lot of difference in the long run.
Drawbacks of Using The Debt Snowball Method
However, you’re going to have one very important con to take a look at. You’re going to spend a little more this way than you would if you spent based on the interest rate that you have on your accounts.
When you have a larger debt it can be a problem because interest charges actually compound. When you push them to the need with this method you’re going to spend a bit more. You’ll spend a bit more when you’re paying interest because you’re waiting longer to pay off this loan.
If you don’t have a big income this could be a bigger problem still. It’s possible you won’t be able to pay the monthly payments.
Now, if you have a loan at 20% and a loan at 3% you may find that it’s strange to pay the minimum on the 20% interest loan just because it’s the highest balance. On the other hand, you’ll need to pay attention to your total loan and interest rates to try and cut down interest as well.
Alternatives to The Snowball Method
The debt snowball is not the only debt reducing method out there. There are a couple of great alternatives you should consider as well, and understand which if them is better for you:
When it comes to the debt avalanche you’re countering the biggest drawback of the snowball method. You may be able to get the debts paid off cheaper this way. If you want to save yourself some money you can take on your highest interest rates before anything else.
Because you’re getting rid of high-interest loans you’re going to pay less in total interest over time and that’s crucial. You’ll save a whole lot of money that way. Of course, if you have a lot of money on that low-interest option you’ll be paying for a long time.
For some people, this can be difficult to stick with because it takes so long to see results. On the other hand, you’ll see that you’re getting the biggest savings money-wise this way.
This is about making one-time payments toward debt, that might be small but happen frequently. We’re talking about debt snowflakes because they’re smaller and you’re only going to be saving a little bit at a time.
If you’re trying to save a little you can immediately apply that directly to the debt itself. This will help you pay off debts a little faster because you can reduce amounts randomly.
Each time you make a payment it’s not going to be huge, but it’s still going to help you decrease things. Every little bit is going to help and you’ll be able to start seeing lower balances a lot. It’s going to give you close to the same results as the debt snowball as well.
With this method, you can also use one of the other forms. You can use the snowflake method with the avalanche or snowball method to get the best results. That way you’re going with whatever fits you best.
How to Choose Your Debt Payment Strategy?
Prioritizing your debt payments is important, but you must also consider them in the context of your other expenses. Remember that before you concentrate on becoming debt-free, you must first ensure that your basic living expenses are covered and that you are not exceeding your monthly budget while working on repayment.
Experts advise determining which debt is causing the most pain before deciding on a repayment strategy. This way, you can prioritize paying that bill in order to improve your financial situation.
Consider Good Debt Vs Bad Debt
The most damaging debt is red zone debt, which typically has the highest interest rates. Credit cards, personal loans, and some private student loans are examples of this. Credit card interest rates, for example, can be as high as 30% and may even compound daily, meaning they can quickly grow even more if not paid off.
Debt in the yellow zone has lower interest rates, is generally for a longer period of time, and may have tax benefits, such as a home equity line of credit or federal student loans, both of which have some deductibility.
Green debt is the longest term with the lowest interest rates, and anything that helps you build an asset. This includes mortgages, which can have rates as low as 2%, as well as some business loans.
You can check out a debt calculator to find out more about whether this is the right method. Whether you’re looking for the avalanche or snowball you can take a closer look here.
If you’re looking for the cheap method the avalanche is the best way to go. Just keep in mind that most people tend to abandon this method. You could find yourself struggling because you’re not seeing results. On the other hand, the snowball can keep you sticking to your plan, though you spend a bit ore.
You don’t have to pick a specific method. Use your own way and according to your own need and specifications to pay your debts in a certain order – is definitely the best.
Paying Off Your Debt Can Leverage Your Finance
Debt repayment necessitates a great deal of motivation. If you want to keep the momentum going in your debt repayment, you must constantly remind yourself of why you want to get out of debt.
How will paying off your past-due bills improve your life? What will you be able to do once you're debt-free that you can't do now? If you're looking for motivation to pay off your debts, here are nine reasons why you should.
- Save on Interest – If you do not pay your debt, it will continue to grow, with interest charges adding to your balance and incurring interest charges of their own.
- Less Stress – Debt can cause additional stress because you are concerned about how you will cover all of your debt payments and other living expenses. A little stress every now and then isn't harmful, but chronic stress can lead to serious health problems such as migraines and even heart attacks. In some cases, paying off your debts can literally save your life.
- Improve Your Credit Score – Having too much debt, particularly credit card debt, can harm your credit score. When your credit card balances exceed your credit limit, your credit score suffers. The same is true if your loan balances are high in comparison to the original borrowed amount. Being debt-free also has the added benefit of assisting in the improvement of your credit score.
Is the snowball method good?
The snowball method is an effective way that you can set up a debt repayment plan. It will see you focusing on paying off whichever of your debt balances has the lowest total. You will then follow this process each time.
The idea is that you will start to build momentum and be more motivated to get your personal debt situation in check. A lot of people have praised the psychological boost that the snowball methods give them. Even paying off small debt balances can provide you with a good level of confidence.
Is it better to put money in savings or pay off debt?
Generally, it is advised that you initially have an emergency fund of savings. This means that in the case of some sort of emergency, you will have the savings on hand that will allow you to ride to the storm.
However, once you have an emergency fund that will cover you for a few months’ worth of living expenses, you can then focus on paying down your debt. This will allow you to get your financial situation under control and not have to continually pay interest on your outstanding debt.
Is it better to pay off small debts first?
There are various schools of thought when it comes to paying off debt. The popular snowball method recommends that you focus on paying off your smallest debt first and proceed in this manner.
The idea is that it will give you momentum and encouragement as you see your debts disappear. Another school of thought pushes the avalanche methods whereby you focus on paying off the debt with the highest interest rate first of all.