Debt Snowball

DEBT SNOWBALL or DEBT ROLL-UP

The overview for this program is you pay more a month than your monthly minimum on one debt while you stay current on all your other debts. You start applying the extra money every month to the smallest balance, and once that balance is paid off you apply all the money from that debt to the next largest balance. This will create a snowball effect in paying off your debt. It is very important that you pay the minimum on all other debts to keep all your accounts in good standing and not create more debt by paying late fees.

How it works:
You must stop using all your credit cards. If you do not do this you are about 95% certain to fail in this method of debt reduction. Next, you make a list of all your debts, rank them by balance size and not interest rate. You will also need to know exactly how much money comes into your household and how much goes out. In other words you need to create a budget. For many of you that is a very unpleasant task. But with out creating a budget you will not be successful in this form of debt reduction.  Part of this method is unlearning the habits that got you in to debt and learning new financial habits for a strong and successful financial future.

Once you have created a budget you can find ways to cut non essentials from your budget and taking that freed up money and using to pay off debt. You can sell luxury cars and buy something more economical. Cut out family vacations. Stop eating out everyday of the week. No more $5 coffee every morning.  Limit clothes shopping to only what you need. I am sure you have stuff in your closets and garages just taking up space. Have a yard sale and or sell it on ebay. There are many ways you can cut cost and find “extra” money in your budget.

So let give an example. First rank your debt by lowest Balance and not interest rate. I will explain more later on this.

Let’s say you have $20,000 in Credit Card debt. Spread over 4 cards:
Credit Card 1: Balance: $6,000 with a monthly payment:    $200
Credit Card 2 Balance: $4,000 with a monthly payment:    $80
Credit Card 3 Balance: $2,000 with a monthly payment:    $40
Credit Card 4 Balance: $8,000 with a monthly payment:    $190

Your total monthly payments on the four credit cards are $510. After creating your budget you were able to cut household cost and find an extra $300 a month in income. (Just by bringing your lunch to work every day and cutting out the Starbucks coffee will get you an extra $300!)

You would make sure you pay the minimum on the following cards.
Credit Card 1: Balance: $6,000 with a monthly payment:    $200
Credit Card 2 Balance: $4,000 with a monthly payment:    $80
Credit Card 4 Balance: $8,000 with a monthly payment:    $190

However you will treat Credit Card 3 different. Instead of paying the minimum of $40, you will pay $340 every month until it’s gone. Once Credit Card 3 is paid off you will apply the monthly payments for Credit Card three to the next largest balance, Credit Card two.

So you will pay the minimums on these cards:
Credit Card 1: Balance: $6,000 with a monthly payment:    $200
Credit Card 4 Balance: $8,000 with a monthly payment:    $190

You will take the $340 used to pay off Credit Card three and use it plus what you currently pay on Credit Card 2 which is $80, so you next payment to Credit Card 2 will be in the amount of  $420. You will continue to pay $420 until you have paid the card in full.

The snowball effect of taking payments from paid of cards and applying them to other debts is taking full effect.

You take the next largest balance Credit Card 1 and apply the $420 dollars you used to pay off Credit Card three plus what you make in current minimum payments on Credit Card one, which will total $620.

Finally you take on Credit Card 4 with a balance of $8,000. So you take the $620 used to pay off Credit Card plus the current minimum for Credit Card 4, which is $190 and now you have a debt crushing payment of $810!

If you pay just the minimum every month you are looking at a 20 year pay off term!!! This method could take you as little as a year or as much as 5 years. It depends on how much money you can afford to apply to debt every month. In my example we started with $300. But some people will start with a lot more or a lot less. If you get a Tax refund every year this is a great way to accelerate the pay off period. Some people cut everything out of their household budget accept for the bare necessities and use all the money to Crush their debt. It boils down to motivation!

Why you should ignore your Interest rate and pay down the smallest balances first?

There are really two schools of thought on this one.
1.    Pay off debts that have the highest interest rates first
2.    Pay off debts that have the lowest balance first.

We highly recommend you pay off small balance debt first!

What? But everyone says to pay off your highest interest rate cards first.

My reason is to build debt crushing momentum. What is that? If you pay off the debts with he smallest balances first you will see actual progress in your debt payoff program. Once one bill is paid off you will take that monthly payment and apply it to the next largest debt you have.  You may have heard the term creating a debt snowball or debt momentum. You need to create momentum early on in your effort to ensure you keep up the debt crushing fight. If you rank your pay off by highest interest rates first, it may take a very long time to see any real movement in your financial situation and therefore you give up.

Pros:
Legally and ethically reduce your debts.
Does not destroy your credit
Helps you budget your household income
Learn wealth building habits

Cons:
Takes time and discipline
Not a quick and easy solution
Must create and live by a budget
You must be really motivated!