What is a debt snowball?
A debt snowball is simply paying off your loan with the smallest outstanding balance first while at the same time making only minimum payments on all other loans. Once the smallest loan is paid off you apply what you were paying to the first loan to the next loan and so on and so forth until all your debt is paid in full. Any extra money you receive will be dedicated to paying off the debt at the top of the list.
Example of how you would create a debt snowball: Smallest Debts Get Paid First
- Credit Card $200
- Credit Card $550
- Student Loan $3,000
- Student loan $5,000
- Car Loan $8,200
- Student Loan: $12,000
- Mortgage: $118,000
I came across this idea after following Dave Ramsey’s 7 Baby Steps to getting out of debt. This approach does not take into account interest rates. The point of paying off the smallest debt rather than the highest interest rate is to create little victories along your journey to becoming debt free. I know when I was getting out of debt it was critical to have these little victories coming right out of the gate. These victories help you build confidence as well as help fuel motivation to keep going.
When getting out of debt do not focus on the interest rate, this isn’t the issue. You need to be focusing on paying off the debt. If your plan is to pay off your debt in 12 months the interest you’re paying becomes irrelevant.
Here is an example:
If you had a $10,000 credit card with a 19% Interest rate you would pay $1,058.84 in interest over the 12 months it took you to pay it off.
Let’s say you could refinance it to a term loan at a 9% interest rate. You would pay $494.12 in interest. Yes, this is a major savings of $564.72 but the point is we are talking about speeding up your debt freedom by about a month.
I used this method personally to pay off my debt and it works. Paying off debt is not a math thing, because if it was we wouldn’t go into debt.
Bottom Line: The debt snowball has you pay the smallest debts off first allowing you to have small victories along your debt free journey. It works because it builds confidence and motivation as you tackle each debt.