If you’re a regular personal finance blog reader, chances are you’ve heard about Dave Ramsey and Debt Snowball. Personally, I have mentioned both Dave Ramsey and Debt Snowball a few times, but never write directly about it. In this article, I’d like to provide a brief introduction, an illustration, and links to related resources.
A Debt Snowball is a debt elimination strategy popularized by Dave Ramsey, a renowned debt and personal finance guru. Under this method, you reduce your debt by paying the minimum monthly payment to all debts, except the one with the smallest balance, which you’ll try to pay down as fast as you can.
The basic steps in the Debt Snowball debt reduction plan are as follows:
The idea is that you’ll be able to pay more toward the “smallest” debt each time a debt is fully paid off.
Let’s say you have 5 outstanding debts in the following amount: $500, $625, $675, $1000, and $1200 — note, the interest rate is irrelevant. To keep this simple, let’s assume each debt requires a minimum payment of $25 per month, and ignore the increases in amount owed due to finance charges. Also, let’s assume you’ve budgeted $200 per months to pay off your debt.
The first month, you’ll pay $25 to all debts, except the $500 debt, which you’ll pay all of the remaining $100 budgeted. After 5 months, the $500 debt would be fully paid and the remaining debts are reduced to: $500, $550, $875, and $1075.
Now, you’ll repeat the same process by paying $25 to all debts, except the $475 debt, which you’ll pay $125 per month ($100 from the $500 debt that was paid off, plus the $25 you originally paid). After 4 months, the second $500 debt is paid off (notice how it’s faster than the first $500), and the remaining debts are reduced to: $450, $775, and $975.
Rinse and repeat…
Here’s the example in a table format to help you visualize the process.
There are many variations of the Debt Snowball methods, i.e., Debt Snowflake, Debt Avalanche, Debt Deluge, etc.
I first heard about Debt Snowflake from Paidtwice. Debt Snowflake is debt reduction plan based on Debt Snowball, but the idea is to actively find and use additional income to pay even more than the budgeted amount toward your top priority debt. Here are a few articles about Debt Snowflake:
The concept of Debt Avalanche is not new, but I believe the term is first used at Consumerism Commentary. Debt Avalanche is similar to Debt Snowball, but the idea is to pay off the highest interest debt first — something I also advocate and wrote in my debt reduction guide. Here are a few articles about Debt Avalanche:
Here are additional articles about Dave Ramsey’s Debt Snowball:
Also, here are two very nice debt reduction calculators to help you decide which method is best — i.e., smallest balance or highest interest rate first.
SavvyMoney is a good financial management application to help you get out of debt. With SavvyMoney, you enter your debt, and then set a payment plan. Your SmartPay plan allows you to apply your payments in the most intelligent way possible. There is also an acceleration element, showing how you can pay off your debt even faster. You can track your progress with regular reports that help you see how quickly you are paying down debt.
By becoming familiar with these debt reduction plans, you’re empowering yourself to get out of debt and avoid bankruptcy. If you don’t know which one to choose, you can’t go wrong with the Debt Snowball method.