Would you like to knock out your debt? Are you ready to lower your debt load, or even become totally debt free? Read on for an explanation and example of the power behind the debt snowball.
Ways To Pay Off Debt
There are four main ways to pay off your debt. Let’s look at them real quick:
- Pay the minimum payments and wait for the term of the loan to end;
- Make additional payments, evenly across all debts;
- Make additional payments, focusing the extra payment on the highest interest rate;
- Or make additional payments, focusing on the lowest balance debt.
That fourth option is called the debt snowball.
How Does The Debt Snowball Work?
To use the debt snowball method:
- List all of your debts, the remaining balance, and the monthly payment
- Pay the minimum payment on all but the lowest balance debt
- When the smallest debt is paid off, add what you were paying to the minimum payment on the second-lowest debt
- Continue down the list, always focusing on the lowest balance debt item
While Dave Ramsey didn’t invent the debt snowball, he certainly made it popular through Financial Peace University and talking to his millions of radio show listeners.
Isn’t a Debt Avalanche Better?
The debt snowball focuses on the smallest balance first, regardless of the interest rate. The debt avalanche method focuses on the highest interest rate debt first, regardless of the balance.
From a purely dollars-and-sense view, the debt avalanche method makes sense. It can save money by lowering the total amount of interest paid over the life of the loans.
But as my buddy Tim says,
“personal finance is more personal than it is finance.”
A plan that you will execute is infinitely better than a plan that doesn’t get followed.
Let’s Check The Math (And Show Charts)
I like charts. You like charts too, right?
Let’s look at a case study now to see how a few different debt payoff methods work out over time.
Here are the details of the debt used in the sample payoff schedules below:
- Credit Card: Balance $16,o00; Interest Rate 24%; Payment $325/month
- Student Loan 1: Balance $30,000; Interest Rate 5%; Payment $150/month
- Student Loan 2: Balance $23,000; Interest Rate 4%; Payment $125/month
- Car Loan 1: Balance $15,000; Interest Rate 3%; Payment $300/month
- Car Loan 2: Balance $5,000; Interest Rate 6%; Payment $250/month
When You Pay Just The Minimum Payments
Making the minimum payments as noted above will have this sample debt load paid off in about 34 years. Over that period of time, you’ll wind up paying over $130k in interest payments!