How does debt snowball work

Include information like the full amount you owe, minimum monthly payment, interest rate and monthly due date, just to stay on track. While you make minimum payments on the rest of your debts, put any extra funds available toward your smallest debt. Wherever extra income comes from, you can put it toward that smallest debt. Then you can apply the money you were paying on that debt to your next-smallest debt.

Do this until all your outstanding debts are paid in full. Wondering how this might actually work? In this example, the medical bill is the smallest debt. So with the snowball method, you put any extra money you have available toward that bill.

Once that bill is paid off, you can focus on the next-smallest bill, credit card 1. Roll the funds you were using to pay the medical bill—and any other extra cash you might have—into paying off that bill next. Once the medical bill and credit card 1 are paid off, the process is repeated with credit card 2, the car loan and then the student loan. The amount you can pay on each bill will continue to snowball until you have all your debts paid off.

While the debt snowball method is good for people who like to see progress quickly as they pay off smaller debts, it may not always be the most cost-efficient strategy in the long run. If you have a lot of outstanding credit card debt or large amounts of debt, this might not be the right plan for you. There are other options to choose from. Instead of focusing on the smallest debt, the avalanche method puts the priority on the debt with the highest interest rate.

It could take longer to see results compared with the debt snowball method, but you can save more in interest payments over the total life of your debts. We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Key Takeaways Debt snowball is a strategy for paying down debts, popularized by personal finance author Dave Ramsey.

It involves paying off your smallest debts first, then moving on to the next smallest, and so on. A competing strategy is debt avalanche, which calls for paying off debts with the highest interest rates first.

Both strategies have their pros and cons. 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 lines of credit. Note Creating a realistic budget that includes debt repayment and prevents you from overspending on credit is key to making the debt snowball method work. Tip Consolidating or refinancing debts at a lower interest rate could help you to pay them off faster when using the debt snowball method.

Related Terms What's a Debt Avalanche? A debt avalanche is an accelerated system of paying down debt that is based on paying the loan with the highest interest rate first. Credit Counseling Credit counseling provides guidance and support for consumer credit, money management, debt management, and budgeting. What Is Financial Literacy?

Financial literacy is the ability to understand and use various financial skills, including personal financial management, budgeting, and investing. Interest Due Interest due represents the dollar amount required to pay the interest cost of a loan for the payment period.

What Is Accelerated Amortization? As with the debt avalanche method, you'd become debt-free in about 11 months. Percentage of U. It's our hunger for instant gratification that makes the snowball method so effective, says personal finance author and talk-show host Dave Ramsey , an advocate of the technique.

You need some quick wins in order to stay pumped enough to get out of debt completely. The debt snowball method's big advantage is that it helps build motivation. Because you see fast results—eliminating some outstanding balances completely in only a few months—it encourages you to stick with the plan. That mountain of debt doesn't seem so unscalable after all.

Plus, it's easy to implement—no need to compare interest rates or APRs; just look at each sum you owe. The big drawback of the debt snowball is that it can be more expensive overall. Because you're prioritizing balances over APRs, you could end up paying more money in interest. Getting completely free and clear could take more time, too, depending on the nature of the debts, and how frequently the interest on them compounds. Both the snowball method and the avalanche method are types of accelerated debt repayment plans —ways of speeding up the retirement of your debts, by paying more than the minimum due on them each month.

Of course, both assume you can afford to commit extra funds to pay down what you owe on a regular basis. If your income is irregular or unstable—or if you think a layoff is imminent—you might want to stick with making minimum payments. If you're applying one of these strategies to credit card balances, they should be credit cards you don't plan to use for new purchases. You can't pay off a balance, obviously, if you're continuously adding to it.

Finally, there may be special circumstances with certain debts that alter your repayment schedule. Whatever debt repayment method you're using, however, you'd definitely want to clear this balance before the special introductory rate period ends—regardless of how it compares to your other bills.

Otherwise, you'll just have added a fresh pile to your interest-rate-bearing obligations. The debt snowball is a type of accelerated debt repayment plan. You list all of your debts from smallest to largest. You then devote extra money each month to paying off the smallest debt first; you make only minimum monthly payments on the others. When the first balance is settled, you move on to the next smallest. The debt snowball can be an effective method for settling just about any type of debt, with the exception of mortgage loans.

A lot of its appeal is psychological. It has the debtor target small balances to pay off first; erasing these "easier" outstanding balances gives a motivational boost, encouraging the debtor to stay disciplined and keep on with their debt repayments—the way the quick loss of a few pounds encourages a dieter to stay with a weight-loss program.

Whether a debt snowball or a debt avalanche is better depends on whether we're speaking in financial or psychological terms. In terms of saving money, a debt avalanche is preferable.

Since it has you pay off debts based on their interest rates—targeting the most expensive ones first—it means you end up paying less in interest. That adds up to paying less money overall—provided you stick with the payment plan.

But, as any behavioral finance expert will tell you, human beings are often irrational when it comes to money. They find it much easier to stay motivated when they pay off smaller debts first, regardless of their interest rates. So, even though it might cost more, the debt snowball is better, psychologically speaking—debtors are more likely to stick with the program because they have a stronger sense of making progress.

Whether you should pay off big debt or small debt first depends on your psychological makeup. Studies have shown that paying off small debts often leaves people feeling more satisfied—small victories, so to speak—and more likely to keep on with a repayment program that eventually clears all their outstanding balances.

Certainly, you get quicker results paying off the small debt, and it simplifies life, to have fewer bills coming in each month. On the other hand, paying off big debt is more cost-efficient in the long run.

The larger your outstanding balance, the more interest it's generating; in fact, a big percentage of your monthly minimum payment is probably going just towards the interest. So, by settling the big debt, you will save on interest, and you will free up funds for other bills and other purposes. Paying off debt has its advantages—especially if you're incurring a high-interest rate on it. With a lot of consumer debt like credit cards , as much as half of the monthly minimum payments go towards interest.

Those interest payments are just money thrown away. A lot of debt will also ding your credit score, making it hard to get financing at good rates if you want to buy a home or other big-ticket item. And finally, paying off debt will free up funds for other things—like savings or investments.

But there are pluses to saving too. You're putting your money to work for you, generating returns and earning interest. And, thanks to the miracle of compounding , your principal can multiply quite a lot over the years.

Since time is a factor, the earlier you start, the better. Of course, much depends on what prevailing interest rates are, and how aggressively you want to invest your funds. As a general rule, if you can earn more interest on your money by investing it than your debts are costing you, it makes sense to invest. If you are serious about tackling your debt, then pick which method is best for your own situation and personality.

The best method is the one you can stick to.