Debt Snowball
The Debt Snowball debt repayment method is a method that has garnered attention from the borrowing public, as well as, the financial world. Dave Ramsey, famed financial expert, radio talk show host, and author of 3 books on debt, developed this method. This method is best applied to debts following revolving types of credit such as credit cards. Ramsey’s strategy works by attacking debts in order of interest rate, from highest rate to lowest. Ramsey suggests that his clients pay off their debts in order of outstanding balance from smallest to largest. In order to get a better understanding of this method please read the following:
- Prioritize your debts from lowest to highest. This will determine which debt you will tackle first. Resolving the first debt is the main concept of the debt snowball strategy.
- Pay the minimum payment on all debt you have. This ensures that you maintain a good credit rating. The debt snowball plan lets you meet all your financial obligations while eliminating them one at a time.
- When the first debt is eliminated, proceed to the second prioritized debt. Apply the amount used to eliminate the first debt to the second debt. This ensures that the extra payment will not create a greater hardship than you are already facing.
- Repeat this process until all your debts are gone. While the debt snowball method take time and discipline, it does work.
This strategy has help many people get out of debt; however, this strategy has come under fire for one main reason, paying debts smallest to largest cost you more money. Try the debt snowball method to see if it will be effective in solving you debt but read the following article to learn the pitfall of the debt snowball method.
Good Strategy or Bad Math
Dave Ramsey’s approach, in some cases, may perform better but understand the debt snowball method may wind up costing you much more in the end. The success of this strategy will depend on the size of your debts. Consider this family with following debts:
Visa -$10,000 @ 14%, min. pymt. = $201/month
Car Loan-30,000@6.44%, min. pymt. = $586.14/month
Student Loan-$14,000@8.25, min. pymt. = $172/month
Visa:
Months to being paid in full: 72
Final amount paid: $14836.13 plus finance charges
Final interest paid: $4836.13
Car Loan: Months to pay in full: 60
Final amount paid: $35,168.50 plus finance charges
Final interest paid: $5168.50
Student Loan:
Months to pay in full: 120
Final amount paid: $20,605.64 plus finance charges
Final interest paid: $6,605.64
After doing the math you can see that, it takes a 120 months and $70,610.30 to pay of the initial debt of $54,000. So far, not too good. Now let us assume that this couple can afford to pay an additional $750 per month towards their debts, which would be better in the end, rather than making only the minimum payments. If you used the debt snowball method and attacked the lowest balance first, your Visa payment would be $951 month. Using this approach, the Visa is paid as follows:
Visa:
Months to pay in full: 12
Total amount paid: $10,774.45 plus finance charges
Total interest paid: $774.45
You have now paid off the Visa, so you can now add the $750 plus the $201 month to the car loan.
Car Loan:Months to pay in full: 25
Total amount paid: $33,504 plus finance charges
Total interest paid: $3504
You have now paid off the Car loan, so you can now add the $951 plus the $586.14 month to the student loan.
Student Loan:Months to pay in full: 7
Total amount paid: $17,487 plus finance charges
Total interest paid: $3487.3
Congratulations, you are debt free in 44 months at a cost of $61,766. That a net savings of $7,766 in interest and 76 months of no payments. Not Bad! However, the Debt Snowball method has many exceptions as is it does not take into account: medical emergencies, vehicle licensing fees, taxes and other unexpected expenses. Additionally, it assumes that you have a large sum of additional cash to apply towards your debts. Many Americans do not have the additional cash to ply to their debts therefore; they abandon the Debt Snowball method.
Now let us look at what happens when you apply the Pay and Play Strategy of highest interest rates first.