Using the Debt Snowball Method

Debt Snowball Method

The Debt Snowball Method is a commonly used strategy for paying off your debt. In this strategy you pay off your debts by account from smallest to largest, reducing the number of accounts more quickly. As a teen or young adult, you most likely don’t have much debt yet, and if so are likely just acquiring debt such as student loans or opening your first credit card. However, it’s important to understand how debt works and effective ways of handling debt so you can be prepared to make the best decisions possible in the future.

 

What Debt Should Be Paid Off First?

The idea behind the Snowball Method is that fewer accounts to pay is less intimidating, and none of your payments slip through the cracks on the “less important” debt accounts. While a retail store credit card may not seem quite as significant as an auto loan, student loan, or home mortgage, it still has the power to have a serious negative effect on your credit if it is neglected. By budgeting to maintaining the minimum payments on all accounts, you eliminate the potential impact of delinquent payments. In addition, focusing on the smallest accounts first, you pay them off faster.

 

How the Debt Snowball Method Works

The Debt Snowball method is fairly simple. Organization is the key, so you’ll need to be sure you have all of your accounts straight and keep track of their balances, due dates, and minimum payments.

  1. List all of your debts from smallest to largest by the balance, or amount owed. This should include the account name, due date, minimum required payment, remaining balance, and any other details you wish to include. This can be very easily set up by using Excel or Google Sheets, or you could go old school with just a notepad and a pen.

 

  1. To start, you identify how much money you have to put towards your bills when you make payments to these accounts, typically each pay period.

 

  1. Accommodate the minimum balance across all debt accounts.

 

  1. Take the amount remaining after all minimum payments and put it towards the account with the smallest balance.

 

  1. Repeat each pay period and watch the smallest debts go away!

Debt Snowball Example

Let’s take a look at a basic example of the Debt Snowball Method. First, list debts sorted by lowest balance.

 

Debt Account Monthly Due Date Minimum Payment Balance
Store Credit Card 13th $20 $68
Bank Credit Card 1st $25 $980
Auto Loan 22nd $215 $7,800
Student Loans 7th $55 $29,000
TOTAL $315 $37,848

 

Now that our debt accounts have been identified, let’s figure out how much we can afford to pay. Of course, you always need to at least hit hit the minimum payment for your accounts, otherwise you can easily fall into credit problems. If you can’t afford to make these payments, you should avoid putting yourself in the debt altogether.

For example, we’ll say we make $1900 per month. We allocate $400 of that for spending money and $1000 into our savings, as part of our personal budget plan. This leaves us with a remaining $500 for the month to put towards paying down our debts. In this Debt Snowball method, we would pay $315 to cover all minimum payments, and then put the remaining $185 towards the smallest debts. This would entirely pay off our Store Credit Card at $68 and reduce our balance on our Bank Credit Card by an additional $117. Our spreadsheet after making payments would look like this (assuming no additional charges took place).

 

Debt Account Monthly Due Date Minimum Payment Balance
Store Credit Card 13th $20 $0
Bank Credit Card 1st $25 $838
Auto Loan 22nd $215 $7,585
Student Loans 7th $55 $28,945
TOTAL $295 $37,368

 

We now only have three accounts to pay on, rather than four. Our monthly minimum payment is reduced to $295. Keep in mind that with credit card accounts, these will change as you use them throughout the month. It’s essential that you update these balances before making any payments or calculations.

 

Pros and Cons of the Debt Snowball Method

The Debt Snowball Method can be a great way to have a plan of attack when it comes to dealing with debt, and very effective in reducing the number of accounts you owe on. Sometimes simply having some structure is all that’s needed to make smarter financial decisions. However, there are of course some drawbacks to this method.

For instance, making minimum payments is not always the way to go. If you have a decent interest rate on the account, and more significant things you should be putting your money towards, then by all means that is the right call. But when you make only minimum payments, you are paying down the interest first. Depending on your rate, you may barely be paying down the principle of the loan at all. This can lead to a long, stressful road ahead.

Another downside to this method is that account balance alone isn’t always what you want to make your financial decisions on. Due date, loan term, personal preference, and especially interest rate, are all other factors that could be more important.

 

Try Other Get Out of Debt Plans as Well

There are tons of other get out of debt plans out there that accommodate for some of these downsides to the Snowball Debt Method. These of course, have pitfalls of their own as well. The Avalanche Method for instance focuses on paying down the higher interest rates first, rather than the lower balances. This doesn’t reduce the number of accounts that you’re paying on as the Snowball Method does, but it can save you quite a bit of money from interest charges in the long run.

As an example, if you have an awesome interest rate on your auto loan, say 1.9%, and your credit card has an interest rate of 23.0%, you’re much better off focusing your payments towards your credit card. These credit cards may seem flashy, with high credit limits and cool rewards programs, but beware of high interest. If you’re able to pay these balances off in full and still maintain your minimum payments on all other accounts, Teen Finance Tips highly recommends that you do.

Feel free to experiment, try a few different methods of paying off debt and figure out what works best for you. Just keep in mind the processes and tips from these methods and you will be fine. As a rule of thumb, do your best to stay out of debt you can’t afford to pay back.