What is Debt Snowballing?

Paying off debts can be a daunting task, particularly when you have got a lot of debts to repay. It may make you anxious and even cause depression if not handled the right way. The first thing that you need to know is that even if you have a lot of debts, they can always be paid off. You simply need to devise a strategy, after considering your situation.

Consider your Income

The first thing that you need to consider when under debt, is your level of income. Are you earning enough to repay the debts on time and take care of your monthly expenses? If you are barely scraping through then it is advised to look for ways to increase your income.

You can search for better-paying jobs or try to set up passive income streams in order to supplement your monthly income. This should be complemented by cost-cutting measures in order to create as many savings as possible. While you are under debt, your priority should be to pay off the debts.

Make a strategy to pay off debts

You will then need to make a strategy to pay off your debts. For this first, you will need to make your debt profile. A debt profile is simply a list of your debt. You can order it any way you like. For instance, you can place the lowest debt first, in the order of ascending debt value.

You can randomly pay off each debt as it becomes due but this strategy only works when your debt is at a manageable level. If you have a lot of debt and are anxious about how to pay it off, you will need a proper debt repayment strategy. Why? Because firstly you cannot allow your mental health to deteriorate because of debt. Yes, debt is a great burden and when it starts affecting your mental health, it becomes even worse.

It has been observed that when individuals start getting anxious about debt repayment, they can slide into a very dark place mentally. Which is why a strategy is needed to make them believe that they can pay off the debt and keep their motivation level high.

Debt snowballing is one such strategy that can help individuals pay off their debt while being motivated. It must be mentioned at the onset that whichever strategy you choose, you will take the same amount of time to pay off the debt because the time required to pay off any debt depends on your income and not the strategy. But having a strategy in place helps in managing the debt load and keeping your focus at the right place.

What is Debt Snowballing?

Debt snowballing is a popular technique to pay off your debts by focusing on the smallest debt first. This strategy is particularly good because it helps borrowers build up momentum and motivation as they go along.

When you focus on the smallest debts first, you get a sense of accomplishment as each debt gets paid off. This creates confidence and allows the borrower to remain in a stable frame of mind.

Steps of Debt Snowballing?

1. List the debts in the order smallest to largest.
2. Make minimum payments on each debt
3. Use the savings to pay off the smallest debt
4. Move on to the next smallest debt.

The order mentioned above is quite simple. First, you have to make a list of your debts. With the smallest debt listed first. Let us look at an example of how this works out. Suppose this is the debt profile of an individual.

Month 1

If a person has the above-mentioned debt profile then the debt snowball method would require them to firstly list the debts from lowest valued debt to the highest valued debt.

Making the list is the easy part. Next, they should make minimum payments on each debt. The minimum payment is the minimum amount of money you can pay on any debt without being charged late penalties. Check your debt papers to know the minimum debt limit for each debt. If you are not sure then contact your lenders to find out the minimum limit, just to be sure.

What this will do is that firstly it will allow you to keep all of your debts current and active, without missing any payment.

The next step is to use the extra amount of savings to pay back the smallest debt first. In our examples suppose that John, whose debt profile has been stated above had set aside $5000 to pay off his debts each month. It can be clearly seen that if he makes the minimum payment on each debt then he only needs to pay $4750. Generating savings of $250. The extra $250 saved should therefore be directed to pay off the payday loan first.

The total amount of payday loan is $300 with $150 being the minimum. This means that the extra savings of $250 can be used to completely pay off the remaining amount of $150 for the payday loan in one go and John will still be left with $100. This extra $100 should be used to pay off the credit card loan.

After a month, therefore, the debt profile would look like this

Month 2

It can be seen that using the debt snowballing method, John has paid off his Payday loan in a single month. The focus should now be on the credit card loan.

It can be seen that now there are extra savings of $400 (5000-4600). These savings can all be directed towards paying off the credit card loan first. After the second month, the debt profile would therefore look like this

Month 3

If we look at month 4, we can see that John has successfully paid off his credit card debt also and is now left with only medium and short term loans.

Month 4

In 4 months, John has paid off Payday and Credit card loans completely. Now he can focus on paying off the auto loan. Once it is paid off he will only be left with long term loans, which will make financial management easier.

It can be seen now that the debt snowballing method helps focus the attention, increase motivation and pay off the debts in an orderly manner. As each debt is paid off, you get more money to pay off the remaining debts.

Debt snowballing is in reality not about maths or finance, it is mainly about behaviour modelling to help indebted individuals pay off and manage their debts.

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