The Debt Snowball!

The Debt Snowball!

Today, I had a brunch & budget with a friend of mine and we went through one of my favorite tricks of the trade: the debt snowball! It’s a pretty simple concept. Most people who have 2 or 3 (or 4 or 5) lines of credit will say, hey, I’ll pay more than the minimum on each of these debts so each of them goes down a little each month.

What ends up happening is most of that money ends up going to the interest and you make hardly noticeable dents in your debt which makes it feel like you’re never going to get out of it. Propell homepage has some great insights into managing and handling debts. Then of course, some kind of emergency pops up (car emergency, hospital emergency, fashion emergency) and you’re not only back where you started, you’re probably in even more debt than before.

Enter the debt snowball. Here’s an example of how the numbers shake out:

1. You have three credit cards with the following balances: $4,000, $5,000, and $600.
2. Minimum payments are: $150 for $4,000 card$200 for the $5,000 card, and $20 for the $600 card. Total minimum payments are $370.
3. You’ve been paying: $250 on the $4,000 card, $400 on the  $5,000 card, and the minimum on the $600 card. Total extra payments across all cards is $300. (stay with me now.)

What if, instead of paying down all the cards, you paid down one card at time? Take that $300 in step 3 and put it all towards one card first. The colors below represent which card is being paid off. In this example, first we pay off the $600 card, then the $5,000 card, then the $4,000 card. The numbers in bold is the remaining balance on the debt we are focusing on paying off:

Month 1:
$600 debt – minimum + $300 (debt is now $300 on this card)
$4,000 debt – $150 minimum
$5,000 debt – $200 minimum

Month 2: 
$300 debt – minimum $300 
$4,000 debt – $150 minimum
$5,000 debt – $200 minimum

Month 3: 
($600 debt is now paid off)
$5,000 debt – $200 minimum + $350 ($50 minimum + $300 of extra payments – debt is now $4,650.)
$4,000 debt – $150 minimum
Remember, you are also paying the minimum so that extra $350 all goes towards the principal

Month 4:  
$4,650 debt- $200 minimum + $350 (debt is now $4,300).
$4,000 debt – $150 minimum

Month 5:
$4,300 debt – $200 minimum + $350 (debt is now $3,950)

. . . Month 16: 
($5,000 debt is now paid off)
$4,000 debt – $150 minimum

Month 17: 
$4,000 debt – $150 minimum + $550 ($200 minimum + $350 – debt is now $3,450)

Month 18
$3,450 debt – $150 minimum + $550 (debt is now $2,900)

Month 19:
$2,900 debt – $150 minimum + $550 (debt is now $2,350)

. . .Month 24:
($4,000 debt is now paid off)

And voila! Debt-free in 2 years.

Which debt should you pay off first, you ask? It really depends. For the logical win, you pick the debt with the highest interest rate and pay that off first. For the psychological win (this is the one I usually go for), you pay off the one with the lowest balance first and move on from there, either choosing to focus on the debt with the next smallest balance or the debt with the highest interest rate, or the debt that is the most annoying for you to have around if you feel like it.

As you pay off one debt, you have more money to put towards the second debt, and once you pay the second debt off, you have money from the first debt and the second debt to pay off the third debt, and around and around we go.

The debt snowball is one of my favorite ways to tackle debt. Nothing like harnessing all your money into one targeted place and watching the balance go way down each month. Yeah!