Dealing with one loan is hard, but juggling multiple loans at once can feel like a complete headache. The good news is that there are strategies to help you manage them all, such as the debt snowball method. This is a simple approach that helps you stay motivated as you deal with debts one by one. Let’s understand what the debt snowball method is, how it works, and how it compares with the debt avalanche method.
What is the Debt Snowball Method?
The debt snowball method is a way you can repay multiple debts. The strategy’s name comes from the snowball effect, where you take a small snowball and let it roll downhill. As the snowball gathers momentum, it gets larger and larger as it reaches the bottom. This debt repayment strategy works similarly. You start by paying off your smallest debt and once it’s fully repaid you use the money you were using for that debt to pay off the next smallest debt. This process continues till all your debts are repaid, with the largest debt being last.
Popularised by Dave Ramsey, the debt snowball method offers several advantages, the biggest being its ability to make you feel accomplished and keep you motivated. Dealing with multiple debts can overwhelm anyone, even to the point it starts to cause anxiety. One may think that they will never be able to pay it all off.
This method encourages you to take the first step of eliminating the smallest debt. That alone gives you a feeling of satisfaction and motivates you to take on the next smallest debt. As you deal with debts one by one, you start to realise that with just a little discipline and momentum you can eventually pay off even the largest debts.
How the Debt Snowball Method Fits into Financial Planning
Debt management is a big part of financial planning. With the debt snowball method, you can eliminate your debts quickly and invest the money you were using for repayment. This strategy helps you stay motivated while also giving you the satisfaction that encourages you to stay committed to the plan. The repayment strategy is also fairly straightforward. You don’t have to think about what to do next, just move on to the smallest debt you have currently and focus on paying it off.
This reduces the financial stress of dealing with multiple debts. It also helps instil financial discipline as you are using your savings to make debt payments regularly. Once the debts are all paid off, you can redirect your monthly savings to Systematic Investment Plans to achieve your financial goals.
How the Debt Snowball Method Works
Here’s how the debt snowball method works:
Step 1
Identify Your Debts – The first step is to list down all your debts and arrange them from smallest to largest.
Step 2
Make All Minimum Payments – The minimum payments help you avoid late fees and penalties.
Step 3
Contribute Towards the Smallest Debt – After making the minimum payments for each loan, use the extra money towards the smallest debt.
Step 4
Focus on the Next Smallest Debt – Once the smallest debt is paid off, divert the money to pay off the next smallest debt.
Step 5
Repeat – Keep repeating this process until all your debts are paid off.
Pros and Cons of the Debt Snowball Method
Pros of Debt Snowball Method –
- This method is very easy to follow as you have to focus on the smallest debt each time regardless of interest rates.
- The biggest advantage of this method is the psychological boost it offers after every ‘win’. With every debt you pay off, you will feel a sense of accomplishment which will help you stay motivated till all your debts are gone.
Cons of Debt Snowball Method –
- This method focuses on the smallest amount of debt and does not factor in the interest rate you have to pay. Over the years, you may actually end up paying more interest and increase the cost of your loans.
- The debt snowball method can also take much longer to pay off, especially if your largest debt is also your highest-interest debt. The longer the repayment period, the more the interest.
Example of the Debt Snowball Method
Suppose Rahul is dealing with these three debts:
- Credit Card – With a Rs. 12,000 balance (and a minimum monthly payment of Rs. 1,000)
- Education Loan – With a Rs. 70,000 balance (and a minimum monthly payment of Rs. 4,000)
- Personal Loan – With a Rs. 30,000 balance (and a minimum monthly payment of Rs. 2,000)
Let’s say that Rahul can afford to put Rs. 9,000 every month toward paying off his debts. The first thing he has to do is make the minimum payments towards all debts except the smallest one, the credit card debt.
He pays Rs. 4,000 + Rs. 2,000 = Rs. 6,000 as minimum payments for the education and personal loan. Rahul now has an extra Rs. 3,000 left in his monthly budget which he can use towards the credit card payment.
Once the credit card is paid off in a few months, he can focus on the next smallest debt, which is the personal loan. He’ll start by making the minimum payment of Rs. 4,000 on his education loan and the remaining Rs. 5,000 he can use to tackle the personal loan.
After the personal loan is all paid off, Rahul can use the entire Rs. 9,000 to work on his education loan until it is fully eliminated.
Debt Snowball Method vs. Debt Avalanche Method
There is another way to tackle multiple debts – the debt avalanche method. This repayment strategy focuses on paying off the loan with the highest interest first. Here are the differences between the two strategies:
| Debt Snowball Method | Debt Avalanche Method |
| The focus is on paying off the smallest debt first. | This method focuses on dealing with the highest-interest debt first. |
| Doesn’t take interest into account, only the debt balance is considered. | It considers the interest rate but not the debt balance. |
| This method helps individuals stay motivated. | This method reduces the overall cost of debt as the interest paid over time is minimised. |
| Preferred by individuals looking for a simpler repayment strategy and encouragement from small wins along the way. | Suitable for people who want to maximise their savings in the long run. |
Conclusion
The debt snowball method is a repayment strategy that allows you to handle multiple debts. This approach focuses on paying off the debt with the smallest balance first, and doesn’t take the interest rate into consideration. The idea behind this is that eliminating the smallest debt will motivate you and will give you the momentum needed to take on the larger debts. It’s also quite simple to follow and highly beneficial for those who need a little psychological help to not feel overwhelmed by debt.
Another strategy, called the debt avalanche method focuses on dealing with the debt with the highest interest rate first. Over time, this strategy can reduce the total cost of debt and help you save more money. One repayment plan is not outright better than the other. The choice between the two depends on your financial situation, goals, and motivation. If you are encouraged by looking at small wins and need motivation to stay on track, the debt snowball method would be a better fit for you.
On the other hand, if you’re more focused on saving money in the long run, the debt avalanche method would be the wiser choice. Either way, remember that the road to being debt-free is long. Stay patient and disciplined, and consider talking with a financial advisor if things get overwhelming. A professional can help you be free of debt in the most efficient way possible while keeping you focused and motivated to achieve your financial goals.
