If you want to pay off several debts, a system front-loaded with rewards can help keep you on track.
That’s the premise of the “snowball” method of debt repayment. (Think of rolling a snowball around to build its size when making a snowman.)
With the debt snowball plan, you pay off debts in order from smallest to largest. Small victories up front — the satisfaction of seeing your debts eliminated one by one — keep you engaged. Dave Ramsey, the author and radio personality, is a fan of this method and encourages listeners to yell “I’m debt-free!” on the radio once their debts are paid.
It’s very different from the “debt avalanche” strategy, which prioritizes high-interest debt. If you need short-term victories to inspire you, you’re a snowball candidate. If you tend to be analytical and patient, the debt avalanche will let you repay debts in the shortest time and with the least interest — but with fewer rewards up front.
Before you start
Calculate your monthly obligations by gathering all your statements for a month.
You’ll need to do some painful math: Add up how much you owe, other than a mortgage. Then compare your monthly expenses (we suggest including savings in that) to your monthly income and make a budget. Hopefully, there’s some money left over. That’s the money you’ll use to eliminate debt.
You might wonder whether you can ever pay off your debt, even with a debt snowball plan to keep you focused. If your unsecured consumer debts — such as credit cards and personal loans — would take more than five years to pay, consider more extreme options for debt relief.
Lastly, while both a snowball and an avalanche involve money you actively budget to pay down debt, you can supplement either with “debt snowflakes” — throwing found money at your target of choice.
Using the debt snowball strategy
First, be sure that you’ve budgeted enough to cover the minimum monthly payment for every debt. Now, arrange the debts by balance, from smallest to largest. Disregard the interest rate on each.
Every month, put the extra money you budgeted for getting rid of debt toward your smallest debt — even if you are paying more interest on a different debt. Once the smallest debt is repaid, take the entire amount you were paying toward it (monthly minimum plus your extra money) and target the next-smallest debt. Keep knocking off debts and then diverting all the freed-up money toward the next debt in line.
Here’s how it could look in real life: If you have a hospital bill for $1,200 that the hospital is allowing you to pay interest-free, and two credit card bills for $5,000 (at 22.9% interest) and $3,000 (at 15.9%), you’d pay the hospital bill first. That’s right — you’d pay the interest-free loan before you paid those that accrue interest.
This can make numbers people crazy, because it flies in the face of math and logic. The debt avalanche method is a better fit for them.
If you choose the snowball strategy and your high-interest debts are the largest, don’t ignore opportunities to find lower rates, especially if your credit score is improving. You may be able to transfer a credit card balance to a lower-rate card or find a debt consolidation loan.
Is a debt snowball for you?
Abandoning rational thought in favor of a sense of achievement when you get rid of a debt can cost you money. And it can mean you’ll spend more time paying.
There’s a chance you might find the same kind of satisfaction using a debt payoff calculator that tracks your balances automatically and suggests where extra cash might help most.
But a plan you abandon — even if it is objectively superior — is a failure. That’s why a less efficient debt snowball may be a good choice for many despite its higher ultimate cost.
A 2012 Northwestern University study of nearly 6,000 debt settlement clients found that, all else equal, how many accounts a person has paid off is a better predictor of eventual success than how much of the balance remains.
There’s abundant evidence that human beings — even the smart ones — are not the most logical creatures. If a debt snowball offers the kind of reinforcement that will keep you motivated, it’s worth the premium to get your finances on track.
Bev O’Shea is a staff writer at NerdWallet, a personal finance website. Email: firstname.lastname@example.org. Twitter: @BeverlyOShea.