Debt Snowballing

If you have debt from student loans, credit cards, or mortgages, fear not! There is a proven technique to pay off your debt faster than you think. It is a debt payoff method commonly referred to as snowballing.

What is snowballing?  Debt snowballing is a technique for paying off debt in which you focus on the loans with the highest interest and pay those off first. Then you use that money to pay off the next highest loan. Then repeat for the next loan, and so on.

How do you snowball debt? To demonstrate the use of the snowball technique, let’s use an example. We will have an imaginary person named Judy, who has $24,000 in debt divided up like this:

Judy’s Debt Amount Interest Rate Minimum Payment
Credit Card $6,000 13% $65
Stafford Loan $7,000 6.8% $36
Perkins Loan $2,000 5% $40
Private Student Loan $7,000 8.13% $55
Car Loan $2,000 5.5% $100
Total $24,000 $296

Judy has a lot of debt from student loans, some credit card debt, and a car loan, all at various interest rates and different minimum monthly payments. Many people would try to pay off the car loan first, because that has the highest payment. But it is actually smarter to pay off the credit card first, because in snowballing, the interest rate is more important than the monthly payments.

To snowball debt, you first want to write down all of your loans, their interest rates, and the monthly payments, as we have done for Judy. Next, go back to your budget and see how much you have each month for paying off loans. Let’s say Judy has $500 available each month to pay off loans.

The trick is to focus on the loan with the highest interest rate. For Judy, that would be the credit card, which has an interst rate of 13%. Judy would first pay the minimum monthly payment on all of her loans. As long as you pay the minimum and pay it on time, you can’t get in trouble. \r\n Now, take the remaining money and put it towards the loan with the highest interest. Continue this until that loan is paid off. For Judy, once she has met the minimum on each of her loans, she will have paid $296, and have $204 left over for paying loans. She will then go back and make another payment on her credit card with the remaining $204. She will keep puting the extra money each month toward her credit card until the credit card is paid off.

Once the highest rate loan is gone, focus on the loan with the next highest interest rate, but this time, use the freed up cash to make even bigger payments on it. For example, Judy was paying a total of $269 per month on her credit card. But now that the credit card is gone, she can focus on the private student loan, which has a rate of 8.13%. She will continue to make the minimum payments on everything, and make an extra payment of $269 per month toward the student loan.

Once that is paid off, she will focus on the next-highest interest rate, which is the Stafford Loan, and put all of here extra money toward that. This process is repeated until all of her loans are paid off.

The trick with snowballing is to always pay the extra amount toward your loans. Once a loan is paid off, don’t take that money and spend it on something else. Instead, take the freed up cash flow and put it into your next loan.

While it could still take a while to pay off the first loan, the process speeds up as debt gets knocked out. So while Judy will be paying a long time to get rid of the credit card, by the time she gets to her lowest rate loan (the Perkins Loan), she will be paying all $500 per month toward the loan. The last loan will be knocked out in just a few months!

The reason snowballing works so well is because it is like compounding interest in reverse. By paying off the loans with the highest interest rate, you are decreasing the total interest you pay over time, while also slowing the growth rate of your loans. This gives you the chance to catch up and pay off the debt. Over the course of a few years, you will save yourself a lot of money by getting rid of your debt once and for all!