How the Debt Snowball Method Works
Did you know that mounting debt is one of the greatest financial concerns for Americans today? Statistics show that 43% of Americans are spending more than they earn annually. Rather than turning to alternatives such as refinancing and debt consolidation, many Americans have chosen to tackle their debt on their own via Debt Snowballing.
The Debt Snowball Method
The principle behind this debt reduction method is to direct your focus on eliminating your smaller debts first and then on to the larger debts. You first create a list of all your debts beginning with the smallest amount owed to the largest. Pay no attention to interest rates unless there are two debts with a similar balance; in this case, give priority to the debt with a higher interest rate.
Continue making the minimum monthly repayments on all debts but add any extra income towards the smallest debt. As you allocate more resources towards the principal on the smaller debts, they will be paid out quicker and then you move on to the next debt on your list and so on.
How to Use the Debt Snowball Method
As an example, let’s say you have made the following list of your debts:
- $550 Personal loan (monthly payment $50)
- $2,500 Chase credit card debt (monthly payment $63)
- $7,000 Capital One credit card debt (monthly payment $135)
For the purpose of this example, the consumer has an extra $500 per month to dedicate to debt repayment beyond the normal minimum monthly repayment.
Step 1: Using this method, the personal loan would be paid off in the first month.
Step 2: With the smallest debt eliminated, the consumer can now allocate an additional $550 (extra income and minimum payment) towards the Chase credit card debt for a total monthly payment of $613. At this rate, the entire debt would be eliminated in only four months.
Step 3: With the first two debts eliminated, the consumer can now raise the monthly payments for the Capital One credit card to $748; this would mean the largest debt would be paid off in a matter of ten months.
Assuming the consumer has stuck with this plan, they would be completely debt free in only 15 months.
Why it Works
The reason this method is so successful is because you modify the spending behavior and repayment strategy, building momentum through small victories. When you focus your energies on the larger debts, you will see a reduction in the total amount owed, but it can be very discouraging if you are still making payments to multiple creditors. By eliminating the smaller debts, the consumer can see tangible progress in their financial plan by focusing repayment to a single creditor. Once they reach the first milestone, the consumer is more motivated to continue making larger payments towards the principal of the remaining debts. When you can see actual results, you will have a better sense of control over your debt and remain confident that you can achieve your goal of becoming debt free.
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