The average American household struggles with over $6,000 in credit card debt, which is small compared to the averages for auto loan and student loan debt. This type of debt can make achieving any sort of financial savings goals next to impossible. While there are hundreds of financial strategies out there to help you tackle paying off your debt, one of the most popular – and proven – strategies is the debt snowball method. This tactic was made famous by Dave Ramsey and has helped thousands of Americans pay off their debt and free up their income for their financial goals.
The debt snowball works by having a person focus on their lowest balance debt first, and then once the balance is paid off, rolling that payment over to the next highest balance. As you knock off more balances, the amount you can put towards the next loan’s payment snowballs as the number of loans you’re responsible for decreases. Here’s an example of the debt snowball in action.
Let’s say you hold the following debt:
You’ll start by focusing the amount of money in your budget you were using towards all of your loans on the smallest loan balance, which is the credit card in this case.
Learn how to create a budget here.
Next, you will figure out what the minimum monthly payment is you have to make on each of your loans. Set that money aside in your budget.
What’s left is the amount you can put towards your credit card. If currently you’re paying $325 towards your debt each month, you find an extra $100 in your budget, and the minimum payments for your auto loan and student loan are $75 and $100 respectively, that leaves $250 to put towards your credit card balance each month. That means your credit card balance will be knocked out in only four months!
Keep the momentum going by adding that $250 payment to the $75 minimum monthly payment on your auto loan, and you’ll be paying $325 towards your auto loan each month. You’ll pay off your car in 14 months, and finally move on to kicking the last of your debt – the student loan. With only one payment to focus on, you can put the entire $425 in your budget towards your student loan. That means in under three years since starting the debt snowball, you’ll be debt free!
Financial experts agree that tackling the debt with the highest interest rate first will save you more money in the long run, so why does the debt snowball focus on the lowest balance? The trick is that snowballing your debt payments appeals more to human behavior, keeping you motivated with small wins that build momentum over time. While you may pay more in interest using this strategy, you’ll be more likely to stay committed to paying off debt when you see the number of loans attached to your name drop.