Building Wealth Magazine

The Debt Snowball is not a new strategy but it has gained a great deal of popularity in recent years as the main debt reduction tool used by syndicated radio host Dave Ramsey. The concept is simple although there are three basic variations.

In the first you take all of your debts and list them in order from highest interest rate to lowest. The advantage to this method is you deduce the debt that cost the most first and over the long run you save the most money.

The second option suggest you list all of your unsecured debt from lowest balance to highest. The benefit of this method is you have a psychological victory of seeing the total number for creditors drop like flies. This method is the best for someone who needs to see results more quickly to sustain the discipline and finish the plan.

The third option is to list the debts in order of which causes you the most stress. If a relative or friend lent you money and you need to get that monkey off your back this may be the option for you.

Once you have selected your basic strategy the next step is to determine how much money you can find to feed your debt snowball. One strategy is to lower you money contributions on your employer 401K to the amount that is matched or even postponing your contributions for up to two years to help eliminate your debt. Other areas to find money include taking lunch to work, making your own morning coffee, and getting a second job. You’ve got to be committed and creative to find the money to eliminate your debt as quickly as possible.
The next step is to make minimum payments to all of your creditors except for the one you are targeting for payoff. Any additional money you have every month should go to pay off this creditor. It is important to have a dollar amount in mind to start your snowball and keep it consistent or growing throughout the plan. Once this creditor is paid off you then move that entire payment amount (The original minimum and the additional) to the next creditor.

As this process becomes automatic you will see these creditors are eliminated faster and faster as the snowball gains speed. The last few creditors are usually eliminated within a few short months of each other.

Below is an example to help you see the power of this strategy. Click Here to see this example.
Ken is a teacher in Palo Alto, CA and wants to become debt free to focus on saving for his children’s education. He started by saving up $1,000 in emergency funds to cover the unexpected and found he can manage $300 per month to pay down his debt. His total debt is $58,416 and his minimum payments are $1,755 every month. He listed this debt from highest interest rate of 18.99% for a $6,567 Credit Card to 4.25% on his $18,370 student loan. He took a second job delivering pizza which brings him an additional $300 per month in income.

By paying $500 per month (his $200 minimum and the additional $300) it took Ken 15 months to eliminate his first creditor. He then added this $500 to the $165 minimum payment to his second credit card which took only 6 months to eliminate. With these two paid he next went after his car payment which he took from $440 per month to $1,105 for 6 months. His home equity loan payment was $400 per month and paid off in 3 months when the payments jumped to $1,505. This left only one month and a $1,313 payment to eliminate the last creditor, Ken’s student loan. So the final tally was over $58,000 in debt paid off in 2 years 8 months. Had Ken paid the minimums and simply added $300 per month in extra payments it would have taken him 12 years and cost an additional $9,500.

Good Job Ken!!!