There are a variety of different strategies you can use to pay off your debts. With the debt snowball method, you start with your smallest debts and work your way up to the largest ones. While it may not save you as much in interest as other repayment methods, the debt snowball method can keep you motivated to continue paring down your debt.
Here is how the debt snowball method works, as well as more about its pros and cons and how it compares to other debt repayment strategies, such as the debt avalanche method.
Key Takeaways
- Debt snowball is a strategy for paying down debts that involves paying off your smallest debts first, then moving on to the next smallest.
- The debt snowball method can be ideal for people who want to stay motivated seeing their debt fully paid down.
- With the debt avalanche method, you pay off debts with the highest interest rates first.
- The debt avalanche method will save you the most money in overall interest.
How the Debt Snowball Method Works
The debt snowball method was made popular by Dave Ramsey, the host of a personal finance radio show and a best-selling author. It starts by identifying the debts you want to pay off. For many people, this may not include a mortgage because a mortgage typically has a lower interest rate than other forms of debt. So, some people prefer to keep that debt and use the extra funds toward investment to earn a higher rate of return.
The snowball method involves these steps:
- First, list the debts you want to pay down in order of their balances, from smallest to largest.
- Pay all the minimum payments. Then, put any extra money toward the smallest debt.
- After the smallest debt has been paid off, put your extra money toward the next smallest debt.
- Continue to allot your extra payments only toward the smallest debt until all of your debts have been paid in full.
Unlike with some other repayment methods, interest rates are not a factor in how you prioritize your debts with the debt snowball method. So, this strategy may not be ideal if you are trying to save the maximum in interest. However, for some people it can be more effective because of the psychological benefits of achieving a "win" each time a debt is paid in full. This can encourage you to continue putting your extra money toward your debt.
Tip
The debt snowball method is typically applied to credit cards, though it also can be used to pay off student loans, auto loans, personal loans, and other types of debt.
Pros and Cons of the Debt Snowball Method
Like many other debt repayment strategies, the debt snowball method has both advantages and disadvantages.
Pros
Can be motivating
Easy to follow
Cons
Does not save maximum interest
Can take longer
Pros
- Can be motivating: Paying off five debts can seem more manageable if the list is quickly whittled down to a single debt by paying off the smaller debts first. The debtor might get frustrated and quit the repayment plan if the highest-interest debt was one of the largest debts and had to be repaid at the beginning of the plan.
- Easy to follow: The debt snowball method is easy to implement, since it doesn't require you to compare annual percentage rates (APRs) for different debts. You simply need to know the balance of each debt to rank them in priority.
Cons
- Does not save maximum interest: The debt snowball method is not necessarily the best choice for saving money on interest. Because you're prioritizing balances over interest rates and only making minimum payments on debts that are low on the list, you could end up paying considerably more in interest over time.
- Can take longer: Again, since the debt snowball method focuses on repaying debts according to their balances, and can allow large, high-interest debts to grow even bigger, it may take you longer to pay off your total debt.
Tip
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How to Apply a Debt Snowball Strategy
Here's an example of how a debt snowball works. Let's say you can afford to put $1,000 every month toward paying off your three sources of debt:
- $2,000 in credit card debt (with a minimum monthly payment of $50)
- $5,000 in auto loan debt (with a minimum monthly payment of $300)
- $30,000 in student loan debt (with a minimum monthly payment of $400)
Using the snowball method of debt repayment, you would need a total of $700 to cover the minimum monthly payments on the auto and student loans. That leaves you with $300 extra to put toward your debt. You'd start with the credit card debt because that is the smallest amount.
Once the credit card debt has been completely paid off, the extra payment can go toward paring down the second-largest debt: the auto loan. After making the $400 minimum monthly payment on the student loan, you can put $600 a month toward the auto loan. Once the auto loan is paid off, the full $1,000 can go toward the student loan until it, too, is paid off and you are debt-free.
Tip
Consolidating or refinancing debts at a lower interest rate can be another way to pay your debts off faster. When you have a lower interest rate, more of your payment amount can go toward the principal.
Debt Snowball vs. Debt Avalanche
The snowball method assumes that you'll receive gratification from paying off smaller debts that will help keep you motivated to pay off larger ones. That may be true for many people.
However, paying off debts with the highest interest rates first—known as the debt avalanche method—will save you the most in total interest. It should also reduce total debt load faster. That's because your high-interest debts will be racking up even more interest while you're just paying the minimum due on them.
In some cases, your smallest debts may also be the ones with the highest interest rates. For example your credit card debt may be your smallest balance and the debt with the highest interest rate. Or, your student loan may be your largest debt and carry the lowest interest rate.
In that case, you don't have to choose between the debt snowball and debt avalanche methods. You can practice both at the same time.
What Is Debt Consolidation?
Debt consolidation refers to taking out a new loan or other form of credit to pay off multiple existing debts, ideally at a lower interest rate. Using a debt consolidation loan is a way to help you pay off debts faster and save money in overall interest.
How Can You Consolidate Credit Card Debt?
You can consolidate credit card debt in a number of ways. One is to take out a lower-interest loan, such as debt consolidation loan, which is a personal loan with a fixed interest rate, and use it to pay off your cards. Another is to transfer your current credit card balances to a new credit card with a lower rate, or one with a low a 0% introductory interest rate for a period of time.
Does Paying Off Debt Hurt Your Credit Score?
Paying off debt can't hurt, and may help, your credit score. One of the important factors in credit scoring formulas is your credit utilization ratio—the amount of debt you're currently carrying as a percentage of all the credit you have available to you. The lower that percentage, the better. However, your score can suffer if you close accounts after paying them off, because having older accounts can work to your advantage.
The Bottom Line
The debt snowball method is one way to get out of debt. It may not save you the most money in the long run, compared to other methods, but it could give you some extra motivation to stay on track. Other strategies for paying down debt include debt consolidation and the debt avalanche method in which you pay off the debt with the highest interest rates first. The right debt repayment plan for you will depend on several factors about your personal financial situation and goals.
