The Snowball Method is a debt reduction strategy that is used by a lot of people today to manage their overwhelming number of debts. The way it works is, you pay off your debts in order of smallest to largest.
Have you ever been taught as a kid that the fastest way to build a snowman is by rolling a small snow ball through the snow? As the ball rolls, it gets bigger and bigger as it picks up momentum until its turned into a boulder.
Well this technique is similar to that, except it’s the debt we’re paying off that’s quicker.
3 Steps to building your debt free snowman
These are the steps in achieving the Snowball Method:
Step 1. List your debts from smallest to largest:
List all the debts and loans that you owe on a piece of paper in the order of smallest to largest.
Step 2. Make minimum payments on all your debts except the smallest:
Make the payments to all your debts at a minimum amount except your smallest debt. Instead, pay as much as you can on your smallest debt. When you focus on one debt at a time, it helps you pay off your balance quickly. Once one of your debts have been paid off, the amount that was used to pay off that debt can be used to pay off your second smallest debt in addition to what you are already paying.
Step 3. Repeat until all debts have been paid:
Repeat this process until all your debts have been paid off. Every time a debt has been paid, use that amount to pay off your next debt.
In our example, if you start paying your home loan first because it’s the largest debt on your list, you’ll be seeing that loan on your list for a while. Despite the numbers dropping every time you pay off the loan, over time you’ll lose steam and stop paying extra.
On the other hand, if you get rid of your smallest debt first, you’ll see progress. Once you start seeing less debts to pay off, you get the motivation to stick to the plan. By the time you are paying off your largest debt, you’ve acquired a lot of money to pay off that debt.
Lets put some figures to the example
For example, if you have the following 3 debts:
1. Credit Card Debt – $2,000 ($50 per month)
2. Vehicle Loan – $8,000 ($145 per month)
3. Home Loan – $300,000 ($1,800 per month)
Make the minimum payment on every debt except your credit card debt. If you are able to increase your monthly pay by $450 a month from taking a side job and reducing your expenses, you would be paying off $500 ($50 + $450) a month on your credit card debt. You would be able to pay off that debt in 4 months, once that’s crossed off the list add the amount you would have paid for the credit card debt to your vehicle loan. So instead of paying $145, you would be paying $645 ($145 + $500) a month on you loan. This would take you roughly 12 months to pay off as opposed to 4.6 years. Now add that amount to your home loan so that your monthly payment is $2,445 ($1,800 + $645) instead of $1,800.
When might the Snowball Method not pay off?
Keep in mind that this method is not for everyone, we all have our own financial circumstances and may not have the flexibility as explained in the method. It could also work out more profitable to be paying off the debt from largest to smallest, you may save more money in interest by doing so as well.