You may have heard of the term “snowball” when a discussion about debt reduction comes up. In case you don’t know what it means, I’ll explain it here.
We’re going to use credit cards as an example, because that’s usually where this strategy is most effective.
The “snowball” refers to what happens when you roll a snowball down a hill – it gets bigger and bigger as it picks up more snow. This general theory is applied to credit card debts, making larger and larger payments as you pick up momentum. Here’s how it works:
Let’s assume you have five credit cards. The balances are $500, $750, $1,100, $2,600, and $3,100. To “snowball” them in paying it all back, you do these steps:
1) First, you have to stop using them (of course).
2) Pay the minimum payment on all of them every month.
3) Figure out what “extra” you can pay. Remember, this is a “get out of debt” plan, so you are going to need a strong commitment. Let’s say that after paying the minimums, you have $70 left to apply to your debt. Add that to the minimum payment to the card with the smallest balance.
4) So, doing the above, you pay the minimum on all five cards, and for the $500 card, you also pay the extra $70.
5) Alright, here’s the snowball in action. When the smallest card is paid off (likely in a few months, since you’re really focusing on it), you now take that entire amount (the minimum you were paying for the smallest card, plus the extra $70) and add it to the minimum payment for the next smallest balance.
Following the above, once the $500 card is done, you are now paying the minimum on the $750 like you always were, plus the minimum you were paying on the $500, plus the extra $70. See how that works? You pay off a card, and take everything you were paying on it and add it to the minimum you’re paying on the next one. And so on. Your payments snowball.
Now, I do realize some financial advisors do not like the debt snowball. They prefer the “debt avalanche” (which means pay off the highest interest card first), as it technically makes more fiscal sense. The problem there is the light at the end of the tunnel could be so far away that you give up (for example, say the highest interest one was the $3,100 one – even with your extra $70 applied to that, it would take years. Do you have that kind of discipline? I know I don’t.
The snowball, for my money, is a lot better. Once you pay off that first card, man, you really begin to build up momentum. It’s almost empowering. Plus, once you get #2 paid, and you’re now using three minimums plus $70 towards #3, the light at the end of the tunnel is so much easier to see.
And now for the corny finisher: Yes, your credit card debt does have a snowball’s chance to get paid off!