If debt repayments are putting pressure on your cash flows, then you need a plan to de-debt yourself and improve your expense structure. In order to do so, you will have to come up with a plan to start paying-off a majority of the outstanding debt that you currently have. If you are reading this, then chances are that you probably cannot simply repay all the debt in one go. You may be struggling to even keep up with the monthly payments.
So, what can you do to get out of debt? If your debt hasn’t gone to uncontrollable levels, then there is a well-known DIY method that you can consider. It’s called the debt snowball method.
Let’s learn more about this debt reduction strategy below!
What is the debt snowball strategy?
Think of the snowball effect where you roll a small palm-sized snowball down a hill covered with snow. As the ball rolls down, it picks up more and more snow until it gradually turns into a massive snow boulder. The snowball theory is based on momentum and how it can be gradually built up to create a large force.
Now apply the same principle to debt repayments. Keep paying all the monthly installments on your debt as you have been doing. Additionally, try to save up some money or create some extra income to make extra payments on your smallest debt. Gradually, with the extra money, you will pay off your smallest debt.
Then, you do the same with the next smallest debt, using the extra cash from your savings to start paying off the next smallest debt. After a while, you will pay off your second smallest debt. Then, you continue the same process with the third smallest debt and so on.
You started small, but over time, you managed to gather momentum and started paying off larger and larger debts. You eventually would pay off all your debt.
An example of debt snowball
Let us assume that you currently have three debts:
- $1,000 of credit card debt with a monthly repayment of $30
- $5,000 of an auto loan with a monthly repayment of $150
- $10,000 of a student loan with a monthly repayment of $300
So, your monthly outflow is the sum of $30, $150, and $300, which equals $480. In order to deleverage yourself, you try and find $50 of extra income or save $50 more than you normally would.
Now, you use that $50 to pay off the $1000 credit card debt. Once that loan is closed out, you have $50 of extra cash plus the money you save by not paying the $30 of credit card monthly payment.
You then use the $80 for the next few months to pay off the auto loan. Then you continue the same and eventually get rid of your student loan as well. This is called the debt snowball method of getting out of debt.
Debt Snowball Tips to Follow
- List Your Debts: Begin by listing all your outstanding debts, including credit cards, personal loans, medical bills, car loans, and any other types of debt. Arrange them in order from the smallest balance to the largest balance. Do not consider interest rates at this point.
- Make Minimum Payments: Continue making the minimum required payments on all your debts to avoid late fees and penalties. This strategy does not prioritize paying extra on high-interest debts right away.
- Focus on the Smallest Debt: Allocate any extra funds or disposable income you have toward the debt with the smallest balance. This is the debt you will concentrate on paying off first.
- Pay as Much as Possible: Devote as much money as you can afford each month to this smallest debt while maintaining minimum payments on your other debts.
- Celebrate Small Victories: Once you’ve paid off the smallest debt, celebrate your achievement. This can be a small reward or a personal milestone celebration. The idea is to create a sense of accomplishment and motivation.
- Move to the Next Debt: With the smallest debt paid off, take the money you were allocating to it (including the minimum payment) and apply it to the next smallest debt on your list. This increases the amount you’re putting toward that debt each month.
- Repeat the Process: Continue this process of paying off one debt at a time, gradually working your way up to larger balances. As you pay off each debt, you have more money to allocate to the next one.
- Snowball Effect: As you clear off smaller debts, you create a “snowball effect.” The amount you’re applying to each subsequent debt grows larger, accelerating the debt payoff process.
- Continue Until Debt-Free: Keep repeating the cycle until you’ve paid off all your debts. You will find that the larger debts are paid off more quickly as you progress, thanks to the growing monthly payments.
The debt snowball method is effective for those who are motivated by quick wins and the psychological boost of paying off smaller debts early. While it may not always save you the most money in interest (compared to strategies that prioritize high-interest debts first), its emphasis on motivation and progress can make it a practical and encouraging approach for debt reduction.
Ultimately, the choice of debt reduction strategy depends on your financial goals, psychological factors, and individual circumstances. Some people prefer the debt snowball method for its motivational benefits, while others may opt for the debt avalanche method, which prioritizes high-interest debts to save more on interest payments in the long run.