How to Break Free from Debt With the Snowball Method

This is a guest post by Anum S. You can also write a guest post on debt advice.

Many folks start their adult life knee-deep in debt, and soon have interest charges accumulate up to their ears due to poor financial planning and lack of foresight. This was my situation! But just last week, I was able to pay off my first college loan and have launched into loan #2! Achieving goals in your battle against debt can be the biggest motivation to press onward. Progressively killing debt has been a topic that a variety of specialists have offered tried and tested ways succeed in. Two methods have been heavily marketed to remedy the situation, but the second specifically was a lifesaver to me!

Decreasing Interest

Under the first method, financial advisors advise borrowers to repay debt in the order of decreasing interest rate liable on each. For example, if your credit card racks up 21%, mortgage claims around 4%, while the loan for your brand new car costs roughly 7%, it would be money-wise to pay minimum obligations on all debts except the one with the highest interest charge. In this case the priority of repayments would be in the below order:

1. Credit Card Debt at 21%
2. Auto Loan at 7%
3. Mortgage at 4%

This method may save money in the long term, but robs the borrower of his motivation to continue to repay his loans, since several roadblocks are met along the road. The primary reason behind individuals failing to eradicate their obligations in a timely fashion according to Dave Ramsey’s experience is that “personal finance is 20% knowledge and 80% behaviour”. Human beings appreciate being rewarded for their behaviour in order to continue with the effort.

Increasing Debt 

Supported by this psychological observation, personal finance experts recommend using the “snowball” approach to reducing debt. This approach introduces the much-needed positive reinforcement into the equation that keeps individuals committed to paying off their obligations. The positive reinforcement stems from the debts being paid off quickly and the reward is the decreasing amount of outstanding debt. The name “snow-ball” is also derived from the fact that as repayments gain momentum, larger debts are eventually paid off. Also, as fewer types of debt remain towards the end, the amount of payments contributed towards their cause grows larger and debts are thus paid off faster, than it would have been possible had they been targeted first.

How Does the Snowball Method Work 

Assume that you have several outstanding liabilities, ranging from $3000 to $100,000, all carrying varying rates of interest. The following is your liabilities’ portfolio:

1. $3,000 at 7%
2. $10,000 at 3%
3. $6,500 at 5%
4. $100,000 at 4%
5. $20,000 at 8%

As demonstrated, according to the first method, the priority would have been to maintain minimum repayments on all loans, while shelling out the maximum sum for the 8%, $20,000 loan. Under the snow-ball method of debt repayment, individuals are required to prioritize repayments according to the lowest value of debt, regardless of the interest rate on each. So by this logic, the following order of repayments would be more appropriate:

1. $3,000 at 7%
2. $6,500 at 5%
3. $10,000 at 3%
4. $20,000 at 8%
5. $100,000 at 4%

By maintaining minimum repayments on the liabilities with lower priorities, this method ensures that debt is quickly paid off. Had the repayment begun from an expensive and a hefty debt amount, it would have been years before the results would show, possibly discouraging the borrower.

Anum S. writes on behalf of InvestmentAdvice.org, an investment and personal finance blog that is geared toward clarifying complicated money matters.

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