Trying to get out of debt can be stressful and even overwhelming. There's an easy strategy you can use to pay off your arrears fast and efficiently. It's called a debt snowball.
Debt snowballs are actually one of the most popular ways to pay off your financial obligations because they simply work. This is also the most efficient way to pay debt since it tackles the highest interest rate balances first. I've explained the entire strategy below so you can use it to become debt-free!
What is a Debt Snowball?
To explain to you what a debt snowball is, I'm going to talk about snow first. Think about winter and a fresh snowstorm that has laid down a nice blanket over everything. You pick up a handful of cold, powdery frozen water and pack it together with your hands. You decide to build a snowman and begin to roll your ball across the ground. As it travels, it accumulates more and more snow on it, growing larger in size. The bigger it gets, the faster it continues to grow.
A debt snowball works the same way except with money and your arrears. The snowball is the money you've managed to pay off from what you owe and/or the amount you're paying on a debt each month. This strategy aims to snowball your debt so it gets paid off faster and faster until it all disappears forever.
The concept is quite simple. Figure out how much you can afford to pay towards your debt each month. Make minimum payments towards all debt each month and then everything left over goes towards your highest interest rate balance. You then continue to pay the same amount each month until all debt is gone. As you pay off accounts in full, you roll over those payments to the next highest interest account.
The first thing you'll need to do to utilize a debt snowball to wipe out your arrears is to set a budget. In particular, you need to figure out how much you can afford to spend each month towards paying off your debt. This will be a combined amount for all debt payments that will be a part of this debt snowball.
Ultimately, the more money you can budget towards your debt payments each month, the more effective this strategy will work and the faster you will be 100% debt-free. First figure out your current monthly budget to see how much is left over that could potentially be applied towards debt. Then re-examine all of your expenses to see if you can cut costs anywhere to boost your debt contributions.
Before you proceed to the next step, you should know a set amount of money that you can spend towards paying off debt each month. If you get a raise or have drastic changes in your living expenses, be sure to revisit this step in the future to make adjustments. It can be really useful to get a raise and add all extra funds towards debt instead of increasing your living expenses.
Debt Interest & Minimum Payments
Now that you know how much you can contribute towards your snowball payments each month, you can proceed to the next step. You'll need to examine all of your debt that you want to be included in this payoff strategy. This should always include credit card balances and personal loans. However, some people will even decide to include their mortgage in the plan.
Personally, I would only list debts that have higher interest rates. If you can make more from an investment than the interest payments on a debt, such as a mortgage, I wouldn't include that in the snowball because that is considered good debt.
You're mainly looking for two numbers for each of your accounts: interest rate and monthly minimum payment. You may also choose to record the account balances so you can see where you owe the most money.
After you have a list of all of your snowball debt including the APR and minimum payment amounts, you can continue to the next step of this strategy.
Rank Your Debt
Now it's time to rank your debt. Your #1 focus here is interest rates. Each account balance will have a different APR assigned to it. The higher the interest rate, the more urgent it is to get rid of that balance because it is costing you more than other debts.
Starting with the highest interest rate first, list all of your debts. At the end of the list should be the account with the lowest interest rate.
Also transfer your minimum payment amounts to this list. You may end up with something like this:
|Account Name||APR||Minimum Payment|
|Capital One Credit Card||26.99%||$53|
|Home Depot Credit Card||22.99%||$25|
Push Your Debt Snowball Downhill
With all of your budget and debt information calculated, you can begin your debt snowball. You have to take the first step and give the snowball a shove to start rolling it downhill. You're also going to need to continue to keep up with these payments each month to keep it moving.
Let's say you have $500 per month that you can spend towards paying off your arrears, and you have the debts that I listed above. First, you'll need to total all of your minimum monthly payments. For this example, it's $203 per month total to make the minimums. That leaves $297 extra per month.
This $297 extra is then paid towards the highest interest rate account. I would end up with these monthly payments:
|Account Name||APR||Minimum Payment||Monthly Payment|
|Capital One Credit Card||26.99%||$53||$350|
|Home Depot Credit Card||22.99%||$25||$25|
The result in this example is a payment of $350 per month towards the highest APR account, the Capital One Credit Card. When I make the final payment on that credit card that reduces its balance to $0, I can cross that item off of the list. Besides paying high APR accounts first, the other key part of the debt snowball is to roll over your payments when you pay an account in full. With Capital One paid off, I would then take that $350 per month and apply it towards the Home Depot card. That would have me paying $375 per month on that card, while still paying $125 on the personal loan.
Once I'm down to the final item on the list, I'm still paying $500 per month, but all of that money is going towards the last account instead of being spread out amongst numerous accounts. At this point, you've successfully snowballed all of your monthly debt payments into a single account by wiping out the highest interest balances first. Just finish paying off the last account to complete your debt snowball!