Paying off multiple debts at once is a daunting task, one that can overwhelm you if you let it. Visible progress is often slow, leading borrowers to feel defeated when they see minimal results from their repayment efforts.
If you relate to the statements above, allow us to introduce you to the Debt Snowball.
With Dave Ramsey’s method of consumer debt elimination, you get what’s missing from other debt repayment strategies: tangible results, momentum, and motivation to follow through.
Intrigued yet? Below we’ve outlined how the debt snowball method works and provided you with the tools to use it.
Now let’s get the figurative [snow] ball rolling to see how Ramsey’s strategy can work for you.
How the Debt Snowball Works
The Debt Snowball, which is featured prominently in Dave Ramsey’s Financial Peace University, assumes you are using a balanced budget and are dedicated to getting out of debt.
Starting a Zero-Based Budget
For the debt snowball method to succeed, you’ll need to work from a zero-based budget.
A zero-based budget is simple: Income-Expenses = Zero
In other words, every dollar you spend should match your income.
With a zero-based income, you know where all of your investments, purchases, and savings go monthly. It saves you time and avoids confusion, allowing you to focus on getting out of debt.
Here are Dave Ramsey’s simple steps to starting a zero-based budget:
- Start by writing down your monthly income. This amount should include everything you bring in.
Bonus tip: Ramsey suggests factoring in savings and giving here because you’re far less likely to give and save down the line. It’s all about priorities, people. - Then, write down your monthly expenses. This category includes everything from rent and utilities to phone bills, food, clothing, and spending money. Be specific!
- Next, include your seasonal expenses. We’re talking about vacations, holidays, and somewhat unforeseen costs like insurance premiums. Expect the unexpected!
- Now, pull in that equation above. Subtract your expense list from your income, and you should see a zero. If the subtraction didn’t give you $0, assign the leftover money somewhere.
Ramsey gives a wise piece of advice here:
If you don’t give it a name, it will be spent.
When every dollar has a job, you’ll have a clear idea of how much money you can put towards paying off your debt each month, letting you work quickly and effectively.
Steps to the Debt Snowball Method
Once your zero-based budget is squared away, you can start the rewarding process of paying off your debts with the debt snowball.
Here’s what you’ll need to do:
- List all your debts (excluding mortgage) from lowest balance to highest balance, regardless of interest rate. (Only consider interest rate when two balances are essentially the same, then list the highest interest rate first).
- Write down the balance and minimum payments.
- Make the minimum payment on each balance except the smallest balance, which you will pay extra on until it is eliminated. You will want to direct every available extra dollar you can find each month to this balance.
- Pay off lowest balance, then direct the funds you were paying on that balance to the next smallest balance.
- Repeat the process.
You can see how each minimum payment will be added to the previous payment, creating the snowball effect.
The Debt Snowball Paradox
Wait a minute? That doesn’t make sense! You aren’t paying off the highest interest rates first! It will take longer to repay your loans!
This is the most controversial feature of the debt snowball.
It’s true. All things being equal, you could pay down your debt faster by repaying your debt with the highest interest rates first.
But one of the main principles Dave Ramsey preaches is “personal finance is 20% head knowledge and 80% behavior.”
By paying off your lowest balances first, you get quick wins, which creates momentum and motivation.
If your highest interest rate is also your highest balance, you will see a minimal improvement each month on your largest bill and little to no improvements on the remaining bills.
Conversely, if you eliminate a couple smaller bills quickly, you will not only see those bills eliminated (which is motivating!), but you will see a larger dent being taken out of your remaining bills each month as your payment snowballs into larger and larger monthly payments.
The Debt Snowball in Practice
Let’s take a look at an actual example of the debt snowball at work.
Imagine you have the three following debts:
- $500 medical bill ($50 payment)
- $3,000 credit card debt ($65 payment)
- $10,000 student loan ($98 payment)
According to the debt snowball method, you’ll make the minimum payments on everything but the medical bill, since it’s your smallest.
Now, let’s say you’re being thrifty and pick up some overtime at work, combining to give you $500 extra a month to put towards repayment. You can now pay $550 a month on the medical bill, comprised of the $50 payment and your extra $500. You’ll now have that debt paid off in a month.
What’s next? Take your $550 and put it towards your credit card debt.
With $615 (remember, you have $550 and the $65 minimum payment), you’ll pay it off in around four months.
2 debts down, 1 to go.
Now, you’re ready to conquer your biggest debt. You can put $713 a month toward your college debt, which means you’ll pay it off in a little over a year.
Because you prioritized and modified your money-managing behavior, you’ve knocked out over $10,000 of debt. It’s that simple.
Calculating Your Own Debt Snowball
That’s just one hypothetical situation. If you’d like to see how you can use the snowball method for your own debt-freeing purposes, try out our debt snowball calculator!
You can also create your own Debt Snowball by using paper and pencil, creating a spreadsheet with Excel or OpenOffice, using a free Excel Debt Snowball spreadsheet, or using a financial management software program like You Need a Budget, which helps you create a working zero-based budget and comes with a free debt snowball spreadsheet.
Deciding if the Debt Snowball Is for You
As with any finance-management method, there are pros and cons to the debt snowball method.
Below are some advantages and disadvantages to the debt snowball method, and some questions to ask yourself as you contemplate using this strategy.
Advantages of Using the Debt Snowball
- Psychological advantage of quick wins.
- Organized method for repaying your debts.
- Encouragement for budgeting and cutting expenses.
- Motivation to stay debt free.
Disadvantages of Using the Debt Snowball
- Not the most effective method mathematically.
- May cost more in interest rates in the long run.
The Deciding Factor
Ultimately, the decision of what debt-repayment strategy to use comes down to you and your tendencies.
Are you someone highly motivated by visible results who’s willing to put in some time, hard work, and savings to become debt-free? If so, the debt snowball method may be a solid choice.
Try out the resources above and take a look at our other articles on becoming debt free, and how paying off credit cards and debt affect your credit score to decide what works for you.
What are your thoughts on the Debt Snowball Method? Have you used it? Did it work for you? Sound off in the comments below.
Kirk Kinder says
I still recommend folks pay off the highest rate first. I understand Dave’s idea about small wins building to a crescendo so what I tell folks is to tally their net worth each month. As they see it grow, that motivates folks to keep going, and the net worth increases quicker when you pay the higher rate cards and debt off first.
It is all how you mentally program yourself though. Some might identify with my approach while others get more from Dave’s. Just go with your instincts.
Ryan says
I can see it working either way. You will have some people who love running the numbers on their net worth and that’s all the motivation they need. While others respond best to seeing debts falling off their list.
I think either way is fine. The key here is directing as much money as you can afford each month to your debt. If you do that you will see quick improvements and eliminate your debt more quickly. This is the case where a plan is better than no plan! 🙂
K.C. says
If there is plenty of cash flow or enough money in savings to avoid taking on new debt while paying off old debts, then paying off the debt with the highest interest makes sense.
However, if cash flow is tight or there is little or no money in savings, then paying off the debt with the lowest balance makes sense, because it immediately improves cash flow which can either be directed to building savings or paying off debt or a combination of the two.
The key to getting out of debt is to quit adding to the debt. That requires either savings or cash flow well in excess of regular monthly expenses.
Ryan says
K.C., the added cash flow is a huge issue, and one that can help people tremendously.
Peter says
I think the reason Ramsey has the “quick wins” approach to paying off debt is because so many of the people he’s talking to have a problem with discipline, and need that extra motivating boost to be able to stick to the debt payoff plan. For most people who see the mathematical advantage of highest interest first, many of them probably aren’t in debt in the first place, so it isn’t an issue. As with most things I don’t think the debt snowball is a one size fits all solution, but it is a good solution for those that need it. 🙂
Ron says
Based on the information you were given, I think I’d do exactly what you recommended. What you really need to know though, are the payment amounts. If student loan 2 was paid down from over $100,000 and had a payment amount of $450, it would get my vote for a quick payoff with the bonus money. Also, it would be helpful to know the reader’s income level in conjunction with the payment amounts as well.
But, given the state of the economy and the precarious nature of employment today, paying off that HELOC first and the car second is very good advice in my opinion.
Ryan says
Ron, that’s a great point. The payment size matters quite a bit. If the student loan 2 and the car loan were both in the $400 per month range, then I would probably pay them both off and use the remaining money toward the HELOC. Then I would use the extra cash flow to direct it toward the HELOC with the intent of paying it off as quickly as possible.
Creating more cash flow offers a lot of financial flexibility and can help avoid taking on more debt.
Nancy says
One disadvantage of paying off student loan debt first is a student loan dies with you – it does not have to be paid by your spouse, etc. So in the event of your untimely demise, your family might be better protected if you pay off your other debt first and die owing your student loans.
Peter says
I think the key for any situation is to examine your situation and apply what will work best for you. Even Dave Ramsey, when faced with phone calls on his radio show telling them their own preferred way to get out of debt usually ends up saying something along the lines of “you can’t go wrong getting out of debt”, or in other words, as long as you’re still making your ways towards debt freedom, you’re good to go.
I probably would have paid off that HELOC as well, although having complete information about the situation would be good too.
JoeTaxpayer says
Here’s my thought. I found a note on Dave’s site where, when asked whether to pay high rate first, he advises the low balance debt snowball instead. We can debate feelings, and whether the success of small payoffs is motivating (sure it is, I don’t dispute it), but Dave dismisses the high rate first approach in a way that I am not comfortable with.
I wrote about this and linked to a spreadsheet site that offered a comparison.
If the high balances also carry higher rates, the cost of snowball can be high. Admittedly, I can (and did) skew the numbers to make a point.
Isn’t it fair to say “be aware of the cost. If the difference is minimal, do what motivates you. If the difference is thousands of dollars over a couple years, think hard before deciding.”?
Mr. Cow says
I usually attribute things like this to DR’s method being an OK fit for anyone but an excellent fit for almost no one. Although I’ve never been in any kind of serious debt (less my mortgage which isn’t addressed in this section), so I guess I have no room to talk. However, I do believe that your assessment does make more sense than the smallest first approach in almost any situation.
Christine says
I think Dave Ramsey’s snowball is a great way to start, if your just on your way to debt freedom. But as time evolves, its good to do what works for you. I like the satisfaction of paying the smaller balances first. And they were usually the highest interest, too. So it worked out.
Also as time evolved, I calculated the difference in interest saved with different payoff scenarios using whatsthecost. And went with what made best sense to me at the time. Now, I am just onto paying Student Loans. Fun (sarcasm). 😉
The Happy Rock says
I agree that there isn’t enough information to make a fully educated decision. Payment amounts and income/amount left each month to pay towards debt would be the two other pieces of information that I would be interested in.
Personally, I might be tempted to go with the car. I just hate car debt and it would probably clear 300-400 a month in cash flow. I would then put the rest on the HELOC. The point being is that I would chose the method that gets you the most energized and eager to kill more debt.
The thing to remember is that even if the payment was applied in normal snowball fashion, we are only talking about a couple hundred bucks in interest in a year that would be lost. Significant, but only really a few weeks of extra payments. So the motivation factor is the key IMO.
Kirk Kinder says
Good advice. I would stick with what you said unless I found out more information like tax bracket, free cash flow, etc.
I wonder why the HELOC is so high. I would look to see if they can get that rate down if they can. However, I wouldn’t close the HELOC as you suggested. Having access to home equity is important unless you have no willpower and having it will cause you to overspend. I always use New Orleans as the reason. Many people who had most of their net worth tied up in their home had no access to money when Katrina hit. If they had a HELOC, they would have been able to draw on it to help them get through a tough time.
Also, the HELOC could help if they have a cash emergency. Even at 10%, it is cheaper than most credit cards, and it is deductible in many instances.
Ryan says
Happy Rock, you’re probably right regarding the car payment – it may be the highest of the bunch, and eliminating it would free up more cash flow, making it easier to deal with future emergencies.
If I were going that route, then I would probably go ahead and eliminate the small student loan as well, just to knock two loans off the books and increase cash flow. Then I would use the payments I was sending for the HELOC…
There really are a lot of factors to consider here!
Jake says
I agree with Kirk. I see no issue with leaving the HELOC open after paying the balance off with that superb bonus. The rate on the loan seems quite high, so I would look into lowering it, if that is possible.
Michael Harr @ TodayForward says
While the minimum monthly payment amounts would be great to have in making this decision, we can generally assume that the HELOC is amortized over a longer period than the auto loan which means the payment-to-balance ratio is higher for the auto loan than the HELOC. In light of this, would definitely have recommended paying off the auto loan first to cut out the highest interest rate first and free up more cash flow (double bonus!). From there, the HELOC would be next in line because of the interest cost, impact on financial security, etc. Student loans (assuming they’re of the federal variety) would be at the back of the bus because they have a low rate and this particular type of loan has a great deal more flexibility than a HELOC in the event of major financial distress (forbearance, forgiveness, etc).
Regardless of payoff order, $15k in debt disappearing from one’s life is a great thing=)
Ryan says
Kirk, good point. I was looking at it from the standpoint of avoiding the temptation for more debt, not the for using it as an emergency source of funds. For some people that is a fine line and should be considered on a case by case basis.
K.C. says
The take-away for me is the distinction Ryan makes between secured debt and unsecured debt. It is an important distinction to make when prioritizing the retirement of debt.
Robert says
I guess from the standpoint that you are making progress paying off debt and it can keep you motivated, this technique is good. However, I think you need to get the most bang for your buck, and approach debt like that.
At the end of the day if this practice is what works for you, go for it.
Derek says
I agree – in general – with the concepts portrayed here and those that Dave Ramsey teaches. But the crux of this is, is the person getting out of debt paying diligent attention to the mathematics of it all.
First, getting out of debt is always a great thing…as mentioned multiple times in previous comments. But I allude to a second principle, which DR common pops off with in his teachings is that ‘if we were good at the math, would we even be in this situation to begin with’ [my paraphrase]. If you know the consequences of interest, compounding, revolving, collateral, etc. – most people might give it a second thought before putting their financial future on the line.