The basic concept of the debt snowball plan is to attack your debt one small piece at a time. First, you stop everything but minimum payments, then pay off your debts one at a time, starting with the smallest debts. The idea behind the debt snowball plan is that by starting with the smaller debts, you’ll be able to see rapid results. Starting with the largest debts can feel overwhelming, like you’re not accomplishing anything at all, and make it difficult to maintain momentum and focus.
Video: Practical Ways to Get Out of Debt
Making a List
First, list out all your outstanding debts in order, with the smallest amounts first. Put everything you can toward the small debts while maintaining minimum payments on the larger ones. As the smaller debts are paid off, the payment is then added in to the payment on the next highest debt, creating a snowball effect, so that payments become larger as you attack larger debts.
Minimum Payments
Making minimum payments on everything but the smallest amounts keeps those creditors happy while you pay off the smaller ticket items, gradually building momentum to tackle the larger outstanding debts. Yes, you’ll accumulate interest payments on those larger bills, which seems counterintuitive, but you’re building your confidence and also building the amount of money you have to pay off those bills, both of which will bring success more quickly than you might imagine.
Extra Payments
Make your extra payments on your lowest outstanding balances to erase them quickly. This gives you quick gratification and a sense of accomplishment that will carry you on to the next goal. By the time you’ve combined these extra payments to tackle your highest debt; you’ll be able to make rapid progress on paying it down.
How the Debt Avalanche Method is More Cost Effective
The debt avalanche method is similar to the debt snowball, but orders your outstanding debt in a different way. Rather than ordering from lowest balance to highest, you order your debt from highest interest rate to lowest interest rate. From there, the method is essentially the same.
Proponents of the debt avalanche method say that it will save you money long-term by eliminated high-interest debts first. The “instant gratification” methods of the debt snowball method can be duplicated with the debt avalanche by setting goals of a certain amount of debt, say $500, paid off, rather than celebrating as you pay off one bill at a time. The debt avalanche, by targeting high-interest bills first, will save you money in the long run. With the debt snowball, if one of your higher balance bills also has a high interest rate, you can end up paying a great deal more in interest, especially if the monthly interest charged on the debt is larger than the monthly minimum payment.
Debt Consolidation and Debt Settlement
If your debt is truly overwhelming, debt consolidation or debt settlement might help you get your head above water. Ideally, debt consolidation combines several debts into one with a lower interest rate and possibly lower minimum payments. With debt settlement, your creditor agrees to consider your debt settled if you agree to pay an agreed upon amount, often less than what you actually owe.
With both debt consolidation and debt settlement, be sure you completely understand all the terms and possible fees before you make a commitment. Some companies that promise low-cost debt relief can end up making your situation worse with high fees and other unacceptable terms.
Video: Dave Ramsey Show Callers Talk About Being Debt Free
EXAMPLE: A real-world example
For your initial list, you would write out all your outstanding debts except for your mortgage and any other large investment debts that constitute more than half your income. A common list might include two or three credit cards with varying balances and interest rates, outstanding medical bills, a car loan, a student loan, and a home equity loan.
Start by paying only the minimum required amount on everything except the lowest credit card balance (or the bill with the highest interest rate, if you’re using the debt avalanche method). Pay as much as you can toward that balance until it’s paid off. Then move on to the next highest credit card bill or interest rate. If you were paying $25 a month on the second card as a minimum payment, and $100 a month on the first card to pay it off, your payment on the second card becomes $125. Continue in this pattern until all your debts are paid down to zero.
