If you can at least make the minimum payments on your debts, the debt snowball method of debt reduction just may be the answer to your debt problems.
The key to this debt elimination tool is focus. You see, two of the most common reasons why people fail at reducing their debts is the feeling of being overwhelmed and/or the feeling that they are not making progress. Snowballing your debt reduction efforts can help eradicate these emotions and get you, and keep you, on the right track.
If you haven't guessed already, the term "snowball" is used as a
metaphor for the momentum that this plan gains as time goes on. This
momentum is what keeps you on track and motivated to keep going and
keep paying down your debts.
Here's and example of how it works...
Let's say that you have four outstanding debts that you want to "snowball".
Student Loan: $10,000 at 5% interest, minimum monthly payment $125
Credit Card #1 (Visa): $8,000 at 19% interest, minimum monthly payment $160
Credit Card #2 (MasterCard): $12,000 at 24% interest, minimum monthly payment $240
Credit Card #3 (Department Store): $2,000 at 21% interest, minimum monthly payment $60
Total Debts: $32,000
Total Monthly Minimum Payments: $585
The first step (even before you start the debt snowball) in this process is to prepare a personal or family budget as the case may be. Preparing a budget is critical to any debt reduction plan because it allows you to start living below your means thus freeing up money each month to help pay down your debts faster.
So, let's assume that according to your new budget you have $750 to apply towards your debt repayments each month.
Now, most people, faced with the above situation, would do one of three things:
1. Continue to just make the minimum payments each month, reasoning that the extra $165 per month could be better spent elsewhere. (By the way, this is the worst thing you could do, as it will take you decades to pay off these debts.)
2. Spread the extra $165 out proportionately over all of your debt payments.
3. Apply the extra $165 to the debt with the highest interest rate until all the debts are paid off.
In theory, there is nothing wrong with #2 or #3, although #3 would be the better choice. However, the debt snowball method takes a slightly different approach.
What makes the snowball method so powerful is not the mathematics behind it, but rather the emotion. The theory is to give yourself small "debt payoff victories" along the way in order to keep you motivated and focused. Here is how the method would be applied to the above example.
Step #1: Write down your
debts, ordered from smallest balance owing
||Name Of Debt
Step #2: Continue to make only the minimum payments on debts #2 through #4. Meanwhile, apply all of the extra $165 that you have to paying down debt #1 each month. After 10 months this debt will be fully paid off.
Step #3: Celebrate the fact that you just paid off one of your debts in full, in just 10 months. Then, re-focus and keep going!
Step #4: Continue to make only the minimum payments on debts #3 and #4. Meanwhile, apply the extra $225 you now have ($165 + $60) towards paying down debt #2. After approximately 2 more years, debt #2 will be paid off completely.
Step #5: Celebrate, focus, repeat... until all of your debts are gone.
Successful debt reduction can sometimes be more about psychology than math. And the debt snowball method focuses on giving you one small psychological victory after another in order to keep you focused and motivated.