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Reduce Debt Using The Debt Snowball Method

debt snowball

Remember as a kid when it would snow, and you couldn’t wait to get out and build a snowman? How it took a bit of effort to get that snowball started, but soon it began gathering momentum, getting bigger faster and faster? Debt reduction works in much the same way…and when all your debt is paid off, you’ll feel just as giddy as you did when you were little.

How The Debt Snowball Method Works

The debt snowball method is a debt reduction strategy where you pay off your debt starting with the smallest bills and progressing to the larger ones, regardless of the interest rate. Once you’ve paid your smallest debt in full, you take the money you were paying on that debt for the next smallest balance. As you do this over and over, you gain more momentum with each one – like a snowball getting bigger and bigger as rolls.

Six Steps To Debt Reduction

  1. With the exception of your mortgage, list all your debts from smallest to largest. This is determined by the amount owed, not the interest rate. However, if two debts are really close in amount, list the higher interest rate one first.
  2. Pay the minimum amount on every debt except the smallest one.
  3. Determine how much extra you can apply to the smallest debt.
  4. Pay the minimum payment, plus the extra amount on your smallest debt until it is paid in full. (note, for some loans such as car loans, you should contact the lender to inform them that the extra amount should go towards principal – not just the next payment which includes interest).
  5. Once the first debt is paid in full, add the minimum payment of the next smallest debt, plus any additional funds, to the next smallest debt.
  6. Repeat until all debts are paid in full!

Example of the Debt Snowball

Let’s say you have the following four debts you need to pay off:

  1. $2,000 credit card debt – $40 minimum payment.*
  2. $5,000 student loan – $59 minimum payment.**
  3. $7,500 credit card debt – $150 minimum payment.*
  4. $12,000 car loan – $232 minimum payment.***

Using the debt snowball method, you would pay the minimum amount on each debt except the $2,000 credit card payment. Let’s say you have an extra $500 a month to put towards that first debt. Combining the extra $500 with your minimum payment of $40 for a total payment of $540 means you’ll pay that baby off in 4 months.

Now, you’ll take that $540 from your credit card debt and add it to the $59 minimum payment on your student loan. By paying $599 each month on your student loan, you’ll be able to say “Adios” to your remaining student debt in 9 months!

Next, you’ll add that $599 to second credit card’s minimum monthly payment of $150, for a total of $749. Now you’re saying “Sayonara” to the rest of your credit card debt in 11 months…Wahoo!!! With 3 down and 1 to go, you’re really rolling (see the snowball reference there?)!

By the time you start paying more than the minimum on your car loan, you’re able to add $749 to your minimum monthly payment of $232. At $981 total per month, your car loan will be paid off in full in 9 months. Thanks to your commitment and focus, you’re debt free in 33 months!

Why It Works

The reason the debt snowball method works has less to do with math and more to do with the psychological benefit of seeing results sooner. By paying the smallest debts first, you’ll see fewer bills as they’re paid off which gives ongoing positive feedback toward the progress of eliminating debt. A 2012 study by Northwestern’s Kellogg School of Management[1] found that “consumers who pursued the “small victories” strategy was more likely to eliminate their entire debt balance” than trying to pay off their high-interest rate credit card first.

A study in the Harvard Business Review[2] showed similar results. Participants who were asked to concentrate on making payments to a single account vs. dispersing them across many showed higher motivation, repaying their debt more quickly.

Choose The Plan That Works For You

While paying off your debts in order of highest to lowest interest rate may be cheaper or faster, if it’s a plan you abandon, then it won’t work. If achieving subgoals (like with the debt snowball method) can help you stick to your plan of reducing or eliminating your debt, it is worth the extra you may pay in interest.

Disclaimer: The information contained herein is general in nature and based on authorities that are subject to change. Churchill Mortgage guarantees neither the accuracy or completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Churchill Mortgage assumes no obligation to inform the reader of any changes that could affect information contained herein. This publication does not, and is not intended to, provide legal, financial, tax or accounting advice, and readers should consult their advisors concerning the application of tax laws to their particular situations.
1.  http://www.kellogg.northwestern.edu/news_articles/2012/snowball-approach.aspx
2. “Research: The Best Strategy for Paying Off Credit Card Debt“. Harvard Business Review.
*Assumes APR of 15.6%
**Assumes APR of 5.05% over 10 years
***Assumes APR of 6% over 5 years

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Eliminate Debt & Take Control of Your Finances

Eliminate Debt With The Rollover Formula

Credit card debt is easy to accumulate but often hard to pay. Many times, people fall into the “minimum trap” when paying their credit cards. Unless you’re using this tactic as part of you’re overall strategy (like below), just paying the minimum due on credit card bills will barely cover the interest you owe, to say nothing of the principal. It will take you years to pay off your balance, and  you could potentially end up spending thousands of dollars more than the original amount you charged. If you carry outstanding balances on two or more credit cards, the rollover formula can help you take charge and eliminate debt. Here’s how it works:

Step 1: Make a larger payment on the card with the highest interest rate and pay the minimum on the rest.
rollover formula 3 credit cards

Step 2: Once this card is paid off, apply the amount of its payment to the minimum amount you were paying on the card with the second highest interest rate.
rollover formula two credit cards

Step 3: When the second card is paid off, add that amount to the payment of the third card, etc. until you have paid off all of your credit cards.
rollover formula one credit card

5 Ways to Eliminate Debt & Take Control

  1. Stop Borrowing from Your Future to Pay for the Present. Don’t use a credit card to pay for things if you can’t afford to pay off your monthly bill in full. There’s no faster way to fall into debt. Instead, put aside some cash each month for larger purchases such as a vacation, so you can pay for it in full. If there’s something you really want, but it’s expensive, save for it over a period of weeks or months before charging it so that you can pay the balance when it’s due and avoid interest charges.
  2. Create a Spending Plan (aka “a budget”).  Most people spend thousands of dollars without much thought as to what they’re buying. A spending plan helps you see where your money is going each month and makes it easier to resist impulse buys and other nonessential purchases.
  3. Expect the Unexpected. It’s tempting to reach for your credit cards when an unforeseen expense arises. However, it’s less stressful to save for it in the first place. Build a cash cushion worth 3-6 months of living expenses by saving a small, consistent amount each paycheck for your emergency fund. If you don’t have an emergency fund, a broken furnace or damaged car can seriously upset your finances.
  4. Watch Where You Borrow. It may be convenient to borrow against your home or your 401(k) to pay off debt, but it can be dangerous. You could lose your home or fall short of your investing goals at retirement.
  5. Get Help as Soon as You Need It. If you have more debt than you can manage, get help before your debt breaks your back. There are reputable debt counseling agencies that may be able to consolidate your debt and assist you in better managing your finances. But there are also a lot of disreputable agencies out there. If you need a referral, I have worked with some good companies.

Paying Off Your Loans

Whether it’s a car loan or a student loan, it’s possible to pay back the amount you borrowed in a short amount of time. Just be sure to check the terms of your loan to ensure that you don’t have any penalties for early payoff.

How Loans Work. Most loan payments are calculated using compounding interest, which is the interest that is added to the principal of the loan each month that the balance is outstanding. You end up paying interest on top of interest. Although compounding interest is designed to work against you, you can pay off your loan three to four times faster with minimal additional cost to you just by knowing your “magic number.”

What’s Your Magic Number? The “magic number” is the portion of your monthly payment that goes towards principal. That’s it; no complicated math required. Pay your loan off quicker by doubling, tripling or quadrupling your principal, or “magic number” each month.

Don’t Be So Quick to Pay Down Your Mortgage

Don’t pour all your cash into paying off a mortgage if you have other debt. Mortgage loans tend to have lower interest rates and are the last debt you should pay off. Keep in mind that unlike other types of loans, you may deduct the interest you pay on the first $1 million of a mortgage loan. If you’re concerned about your mortgage rate and want to lower your monthly payments, consider contacting us to refinance.

The Bottom Line

Eliminating debt can seem overwhelming, but if you break it up into small steps, you’ll be on your way to being debt free in no time! If you’d like to share additional debt elimination techniques, post to our comments section.

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