Are you overwhelmed with debt and don’t know where to start?
The best place to start is with a strategy. There are few different debt reduction strategies but the most popular are the debt snowball and the debt avalanche. The debt snowball lists balances from smallest to largest while the avalanche lists interest rates from highest to lowest. Start small with the debt snowball.
Debt Snowball
The debt snowball was made popular by Dave Ramsey and focuses on paying off the smallest debts first. Critics of this method say, “You should pay off the highest interest rate because mathematically it’s correct.” But proponents come back saying, “If you were doing math, you wouldn’t be in credit card debt.”
The problem is not math and therefore cannot be solved with math. The snowball method deals with the heart and behavior issues of money management. Dave says that personal finance is 80% behavior and 20% head-knowledge. How you manage money stems from your behavior with it and has little regard to how much you have or make.
Once we understand that money management is a behavioral and psychological issue problem, you can solve it with a behavioral and psychological answer. The debt snowball gives you the satisfaction of paying off small debts quickly and instills the confidence and hope in you that you are making progress! Not only do these wins provide you with the motivation to keep going, they help build up momentum – just like a snowball does when rolling down a hill.
Step 1
Gather up all of your debts. Let’s say you have 8 different debts, made up of: 2 credit cards, 4 student loans, 1 medical bill, and 1 auto payment. The first thing you need to do is organize them from smallest to largest.
| Loan | Balance |
| Student Loan | $1,500 |
| Credit Card | $1,800 |
| Student Loan | $1,900 |
| Medical Bill | $2,800 |
| Credit Card | $3,000 |
| Student Loan | $6,000 |
| Student Loan | $9,000 |
| Auto Loan | $13,000 |
Step 2
Make minimum payments on all loans except the smallest, where you’ll pay more. As well as paying the minimum on the smallest, throw any extra money you can come up with at the smallest debt. Let’s say that after a hard look at your finances, you found ways to save on your grocery budget, reduce your coffee shop spending, and lower your utility bill by turning off the A/C and using less water. You were able to come up with $300 extra a month – YAY!
While paying minimum payments on all debts, put the extra $300 on the smallest one. In this example, the smallest debt is a student loan of $1,500 with a minimum payment of $20. When you add the extra $300 to the $20 minimum payment, you are then paying $320 each month until the student loan is gone. This should take a little under 5 months.
| Loan | Balance | Minimum Payment |
| Student Loan | $1,500 | $20 + $300 = $320 |
| Credit Card | $1,800 | $20 |
| Student Loan | $1,900 | $20 |
| Medical Bill | $2,800 | $30 |
| Credit Card | $3,000 | $30 |
| Student Loan | $6,000 | $60 |
| Student Loan | $9,000 | $100 |
| Auto Loan | $13,000 | $300 |
Then comes the happy dance. YOU JUST PAID OFF A LOAN!! Had you continued to make minimum payments only on that loan, it would have taken over 6 years to pay that back (and that’s not including interest) but you just did it in under 5 months!!
Step 3
Once the smallest debt is paid off, roll all the money you were paying into the next smallest. In this example, we add $320 to the credit card debt that has a minimum payment of $20 to get $340. This creates the snowball effect. Once you’ve paid off that credit card, celebrate!! You can now cross off 2 loans!
| Loan | Balance | Minimum Payment |
| Credit Card | $1,800 | $20 + $320 = $340 |
| Student Loan | $1,900 | $20 |
| Medical Bill | $2,800 | $30 |
| Credit Card | $3,000 | $30 |
| Student Loan | $6,000 | $60 |
| Student Loan | $9,000 | $100 |
| Auto Loan | $13,000 | $300 |
Step 4
Continue adding the previous payment to the next until debts are paid. The final snowball will look a little something like this:
| Loan | Balance | Minimum Payment |
| Auto Loan | $13,000 | $300 + $580 = $880 |
As you work your way to the end of the debt snowball, you will be making your biggest payments on your biggest loan because that is your only loan left! While on this debt free journey, you may start to see some changes. You’ll probably look for an side job that brings in more to throw at the debt, thereby increasing your income. Paying off debt forces you to be disciplined which is a rich quality that will carry through to other parts of your life.
Looking for ways to save a little extra cash each month? Check out this post by The Money Family on 18 frugal living tips that will help you save money!
Also check out Dave Ramsey’s book The Total Money Makeover to learn more about paying off debt using the debt snowball.
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Now it’s your turn: let in me know in the comments below if you’ve used the debt snowball method or what debt reduction strategy has worked for you?
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This is good to know: “The problem is not math and therefore cannot be solved with math”. Very interesting. I also appreciated what you said about paying off debt forces you to be disciplined which is a quality to carry into other areas of life. Great point!
I’ve found in my own life that once we decided to get our finances in gear, other areas got some needed attention, too!