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!
That’s an image from the debt management module used for my financial planning clients. This shows the balance of the debt total over time as it gets paid down.
When You Have An Extra $250 To Pay Down Debt
Let’s now consider if you have an extra $250 per month you could put toward debt payments. The easiest way to allocate this money would be to split it across the debts. Five debt payments, so we’ll allocate $50 to each.
How does that look?
Wow. Big difference huh? Just paying an additional $250 per month in this case would make you debt free 15 years sooner! And it would save more than $30,000 of interest payments!
Well, that’s pretty powerful. If you thought that paying a few hundred extra each month on your debt was a waste of time, I hope you’re rethinking that now.
It can make a HUGE difference.
What If You Debt Avalanche With The Extra Amount?
OK. Now consider if you are purposeful in how you allocate that extra $250/month. This time we’ll consider a debt avalanche, which would be focusing on the debt with the highest interest rate first.
It’s getting REALLY exciting now!
Just by reallocating the payments you will save another $20k worth of interest payments.
You also cut another 13 years off the time it takes to be 100% debt-free!
How Does The Debt Snowball Stack Up?
I already warned you that from a pure numbers perspective the avalanche saves more than the debt snowball. How much though? Just in case you’re thinking “well, I’m smarter than average so I can stick with a debt avalanche”, here’s more to think about.
Maybe you can.
But is it worth it?
Here is how the debt pay off looks when using the debt snowball method and that same extra $250/month.
While still an impressive savings, the debt snowball in this example takes an additional three months to complete, and costs several thousand dollars in interest payments.
Forget that! Go with the option that saves the most money, right!?!
If it were about paying the least amount of interest possible, people wouldn’t be in debt in the first place. They’d pay cash and avoid any interest payments.
It isn’t just about the finance – it’s personal. It’s mental and emotional. Dave Ramsey says “its the guy in the mirror” that messes him up.
Studies show that using this debt snowball method – even though not the best “math-wise” – is your best chance of getting out of debt.
What’s Your Debt Pay Off Plan?
Are you currently paying off your debt? If so, what method have you been using? Has it been working well for you? Will you consider changing methods after reading this post?
If you would like to work with a financial coach to build a custom financial plan to achieve your goals, just reach out. It doesn’t cost anything to set up an initial phone call to discuss your needs and see how a workable financial plan might help you live the life of your dreams.