What is a Debt “Snowball”?

woman in the snow

Photo Credit DjCodin from www.freedigitalphotos.net

A reader asked us last week “what’s a snowball?” Fair question. We’re talking money, not weather here at DebtKid.

Here’s the answer, the best that I can give it to you, but it is further explained in the “Total Money Makeover” by Dave Ramsey. (I highly recommend the audio-book personally).

Imagine a snowball rolling downhill. It gets bigger, right?

Some financial experts teach you to pay off your debts beginning with the highest interest rate. Dave Ramsey, on the other hand will teach you to pay them off smallest balance to largest balance. It doesn’t make much mathematical sense, but it does make sense in other ways.

First, it gives you a sense of accomplishment. When you’re feeling crushed by debt, a few quick wins feel really, really good. Good enough to work as hard as you need to in order to get out of debt. There’s a real psychological boost. Second, there’s a cash-flow advantage to it.

Two words of caution. The debt snowball will only work for you if you’re on a budget and planning a certain amount of income each month towards your debt at a minimum (extra is always good too). You also need to have a small emergency cash reserve in place just in case. This is so that you don’t need to resort to creating more debt, but be sure that it is not so much that you might be comfortable being in debt. (Debt-busting is not about comfort and relaxation!)

Here’s how you “roll” the snowball.
1.List your bills smallest to largest citing the total balance owed, and the minimum payment on each.
2.Pay off the bills as fast as you can with the smallest. Plan on a minimum payment for every bill and direct any extra towards the top of the list—the smallest bill. In our house, we knocked out the first three bills for a total of about $200 in the first month. This freed up an additional $200 the next month. There’s your cash flow advantage. Rather than just paying minimums, as soon as you get a small bill out of the way there’s a little extra money wiggle room to make even more progress on the next bill. This month I’m paying off a card that has a $209 minimum monthly payment, which is freeing me to make a whole lot more progress every month on my last remaining debt.
3.Any time you have extra, unexpected money (tax return, birthday card from grandma or yard sale money) immediately send it to your smallest bill. What looked like a bunch of $30 and $50 payments suddenly becomes real money once they’ve all vanished and you have that extra cash every month to throw at the big looming debts.

Many criticize this method because it has no regard for the interest. Certainly, I’d bypass this method if I had a few small medical bills at 0% interest and some payday loans at 800% in the middle, but otherwise, this method if followed with intensity can usually be worked in 18 months to two years, so the difference between one credit card at 8% and one at 12% in my family has made very little difference.

Being in debt is like being eaten alive by a duck...

Being in debt is like being eaten alive by a duck...

There are a number of schools of thought on debt payoffs.

-Highest interest first—Suze Orman
-Smallest payment first—My financial planner from USAA
-Debt Snowball (smallest balance to largest balance)—Dave Ramsey
-Secured debt first, unsecured later—source unknown

I must confess, I’ve tried all of these methods in the past ten years, and the only one that has worked for me is the Debt Snowball. Why?

It’s all psychological.

I can do math as good as the next guy, and I know it doesn’t make sense to leave a credit card balance out there and pay off a subsidized student loan, but I also know myself and I don’t like to fight loosing battles.

Progress for me can’t be measured in tiny bites. I’ve said it before; being in debt is like being eaten alive by a duck. One doesn’t notice one little bite—or maybe even two. Before long though, it’s all out of hand.

For me to feel progress, I’ve got to take big whopping steps—burning the village steps—to feel like I’m making progress.

Listing my debts smallest to largest and working up the list feels good. The list lives by my computer on an index card and gets updated monthly. I cross off debts. I ring a bell, or twitter or have the kids do a happy dance—whatever strikes my fancy. We put payoff certificates on the fridge and celebrate them like an honor roll report card. It’s mom and dad’s report card for doing well. We can now officially take off the dunce caps we’ve been wearing (they respectively read “Visa” and “Master Card”).

It feels good know I’m becoming debt free.

This year, we received a very large tax refund due to our claiming the adoption tax credit. The intention of this was to pay off the plane tickets we’d purchased to adopt our daughter (still on a Master Card at 8%). Instead, we used it and paid off two smaller loans—an adoption loan of $4,000 and the remaining $2,000 on a student loan. The rest was applied to other small debts.

I know I could have made a serious dent in the credit card debt, but instead, we received two certificates of payoff, and whacked off half of our “smallest to largest” list—even if it is just half in length, not half the outstanding balance.

I think I know why it’s called the snowball.

Like a snowball rolling down hill, claiming more snow as it rolls, our cashflow has improved with each of these payoffs—substantially! Each of those little debts we paid off had a pretty high monthly payment. That $15,000 credit card balance has a monthly payment of about $42, but the student loan was $110, and the adoption loan was $150 and there were some other small loans in the $100/mo range. Having all of those paid off frees up several hundred dollars per month to apply towards our bigger debts.

Finally, we see progress on those bigger debts. Stretching and straining to send an extra $200 or $300 per month was miserable, but now we automatically send $200 or $300, and stretch or strain a little bit and send another $200 to be dropping our balance measurably each month. That feels good.

So good in fact, that it’s becoming addictive.

Now, each time my husband takes on some overtime hours, or I take on an extra project, the money we earn is earmarked for those bigger debts. The whole family is seeing progress and the excitement has caught. We’re getting “gazelle intense” about busting our debt….and it is fun.

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  • Edwin

    While I’m not an adherent fan of Dave Ramsey, I agree 100% with the debt snowball method. It clearly isn’t mathematically the best method but psychologically it definitely works far better and keeps people on track.

  • http://www.lakehousechronicles.com/GetOutofDebt.html Eric

    Good Information. I love uncle dave and have found the debt snowball to rock! Keep up the good work! CHEEEETTAAAAHHHHHHH!!!!!