How do you pay off your debts, specially on your credit cards?
Do you spread your payments across them? Do you pay whichever calls or contacts you first or those who are persistent with their payment demands?
In the past, when I was still struggling with my finances, I discovered a debt reduction strategy which made it possible for me to eliminate my debt with ease – it’s called the snowball method.
You might have already heard about it, for many personal finance experts actually recommend this strategy.
The reason is because the debt-snowball method allows you to eliminate your debt while incurring the least amount of interest fees in the process; at best – it fosters self-discipline and motivates you to take your finances seriously.
So how does the debt-snowball method work? Below are the basic steps.
Debt-Snowball Step by Step
- List all your debts from smallest to largest balance.
- If two debts are tied in the amount, or is very close, put the one with the higher interest first
- Write down the minimum monthly payment required for each debt
- Budget your finances so you can pay the total minimum amount every month
- Then determine and commit an extra amount of income which you will add to your debt payments
- Each month, pay the minimum required to each debt BUT ADD the extra amount to the payment of the first debt on your list (the debt with the smallest balance)
- Do this until the first debt on your list is fully paid
- Next month after that, take the minimum payment from the first debt PLUS the extra amount you were paying and ADD it to the minimum payment required of the next debt on the list
- Repeat this process for each debt on your list until everything is paid
And that’s it! That’s how simple it is.
Still confused? Then here’s an illustrated example of how this works:
In the example, you committed to pay an extra 1,000 every month on top of the minimum required. And by using the snowball method, you’ll see that each debt gets paid faster and faster, with all debts paid by Month 24 (Credit Card C balance will be fully paid by that time).
Debt-Snowball Highest-Interest Method
The strategy described above is the traditional debt-snowball method. There is a variation to this strategy that promises to pay your debts faster with less interest fees incurred.
Instead of paying from smallest balance to largest, you pay from highest interest to lowest. Thus, your list would look like this:
And the rest of the method is the same – you snowball your payments from one debt to another until everything is paid.
Which method is better?
I’d say the highest-interest method but only because it’s more financially smart mathematically. The traditional method of eliminating the smallest debt first gives “quick wins” which has psychological benefits.
Paying your debts is more than just about the money and the discipline, a good part of it is also having the motivation to cross the finish line. So whichever method works for you is fine as long as you persist and become free from debt.
Several assumptions were made in the examples above and the shown computations may slightly vary from real life situations. This was done to make the presentation simpler to the readers. I believe that what is more important here is to understand how the method is done and why it works.
Photo credit: kamshots
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