Debt Snowball Method: The most effective way to get out of debt on your own
Debt is one of the most controversial topics and generates the most debate regarding financial education.
This is because there are different ways to see, use, and pay off debt. Some people can have control over it, while others seem to have their lives dominated by it when it spirals out of control.
Although some types of debt can be considered "good," in general, debt has a negative impact on our lives. It causes stress, anxiety, frustration, and prevents us from making progress in our financial journey.
It is very easy for debts to spiral out of control in the blink of an eye, and it is at this point that worries begin, and many start to ignore the problem, as stress, anxiety, and worry make it difficult to deal with the situation. After all, it is normal to reject negative situations in our lives and to overlook everything that creates anxiety. The problem is that this issue worsens as it is ignored, since due to the way interest works, the debt itself becomes larger and larger, and it becomes increasingly difficult to pay off.
For many, the constant struggle against debts becomes an emotional and financial roller coaster. That’s why it’s crucial to explore effective methods tailored to our particular situation. Not all methods will work for everyone, as there are different cases.
Debt: The Good and the Bad
Debt can be divided into two main categories: good and bad. "Good" debt is considered to be that which is taken on for the purpose of investing in assets that create value over time. For example, taking out a mortgage to buy a house or a loan for the expansion of our business can be examples of "good" debts. These debts have the potential to increase our net worth over the long term.
On the other hand, "bad" debt is that which is incurred to finance consumption expenses or expenses that do not generate long-term value. Credit cards are often the most common example of "bad" debts. By accumulating balances on credit cards, we pay ridiculously high interest rates and can easily get trapped in a cycle that makes it difficult to get ahead financially.
Putting It Into Perspective
The average interest rate on credit cards in the United States stands at 21% annually.
If we take on credit card debt of USD $10,000 and the person makes payments of USD $200 per month to pay off this debt, it would take them 120 months (10 years) to pay it off in full, and they would have paid a total of USD $13,972 in interest. They would have paid more in interest than on their original debt.
Do you know all the things you could do with $13,972 to improve your finances and increase your wealth in the future? Well, if you save it in a high-yield savings account (HYSA) at 4% annually, you would have $20,682 after 10 years.
If you invest it in a diversified portfolio of stocks and bonds, expecting a compound annual return of 8%, after 10 years you would have around $30,164. And if you wait 10 more years, you would have around $65,123, without contributing an additional $1. Your $13,972 would have multiplied by more than 4 times.
The truth is that this person did have that $13,972 to save and/or invest, but it disappeared because it was the bank's profits from that debt taken on in the first place.
This is precisely why if we have debts, our priority is to get out of them as soon as possible and thus take control of our money and our financial future once and for all, instead of spending on things we don't need and can't afford.
For this, there are different methods that can be implemented depending on each person’s situation, and one of the most popular and effective is the Debt Snowball Method. We explain it in detail below:
Debt Snowball Method
The Snowball Method is a super effective strategy for gradually and motivationally eliminating debt. The success of this method lies in its simplicity and how it leverages human psychology to keep us committed to our goal of getting out of debt.
This method involves following these steps:
Debt List: List all your debts and arrange them from smallest to largest amount, from the smallest to the largest, regardless of the interest rate. Also include the minimum payment of each one in your list. Do not include your housing debt, as there is no need to prioritize its payment when you have other types of debt.
Minimum Payment: You will make the minimum payment on all your debts except for the smallest one. In this case, you would pay the minimum on all debts except for Credit Card #1.
Attack the Smallest Debt: We will focus all the extra resources we have after making the minimum payments on the smallest debt. Pay more than the minimum, as much as you can. If our budget allows for $1,500 a month in debts, we would allocate $1,000 to minimum payments and $500 all at once to Credit Card #1.
Snowball: Continue this process until you are free from debt #1, and once you have paid it off, take that amount to the next one on the list. Now you are attacking the second debt with a larger amount: $500 that you have remaining after eliminating debt #1 and $50 that you were paying as the minimum on Credit Card #2.
Repeat and Increase: Repeat this process with each debt. As you progress, the snowball gets bigger. You will see how you are getting out of debts faster thanks to the focus you are giving it, and you will be able to pay increasingly larger sums towards the subsequent debts.
The Snowball Method is so effective due to the sense of accomplishment it provides. By eliminating small debts first, there is a feeling of quick and tangible progress. Seeing debts eliminated one by one gives a psychological effect of achievement and motivation that helps us keep going and creates an emotional momentum to continue paying off the remaining debts.
Considerations
Like everything, there are considerations to keep in mind. While there are no specific rules when it comes to paying debts and managing our money, we believe there are certain aspects that should be considered.
This method involves paying our debts from smallest to largest balance regardless of the interest rate, which works perfectly in the example we showed earlier. However, what happens if we have, for example, a car loan of only $3,000 at an 8% annual rate and a credit card of $5,000 at an annual 25% rate?
According to this method, we should pay off the car debt before the credit card, but this could cost us very, very dearly. Paying only the minimum on a debt with a 25% annual interest rate while focusing on paying off another debt at 8% annually means we are paying much more in interest unnecessarily up to a point.
That is why we believe that for this method, debts should be organized by category and by amount, and from there we should start our snowball.
Classifying by category means grouping the debts that are considered secured, like a car loan or any other loan that has collateral, then the unsecured ones, like student loans and personal loans, which do not have collateral but lend us a fixed amount (we cannot pay it and have the same credit available later), and revolving debts, which are those we can access at any time and as we pay them off, we regain access to that credit again, like credit cards.
We will want to prioritize in our list, regardless of each amount, the revolving debts. Therefore, if we have:
💳 CC: $6,000 25%
💳 CC: $1,000 29%
💳 CC: $2,500 26%
💳 CC: $500 23%
💵 Personal Loan: $3,500 15%
🎓 Student Loan: $10,000 5%
🚗 Car Loan: $4,500 6%
🚗 Car Loan: $15,000 9%
The optimal order for getting out of these debts using the Snowball Method should be:
Revolving Debts (Priority)
💳 CC #4: $500 23%
💳 CC #2: $1,000 29%
💳 CC #2: $2,500 26%
💳 CC #1: $6,000 25%
Secured/Unsecured (Second Priority)
💵 Personal Loan: $3,500 15%
🚗 Car Loan #1: $4,500 6%
🎓 Student Loan: $10,000 5%
🚗 Car Loan #2: $15,000 9%
Even if we have 2 loans (Personal Loan and Car Loan #1) with an amount lower than that of a credit card, we should not prioritize paying these loans before the credit card just because they have a significantly lower interest rate.
As revolving debts tend to have the highest interest, we would prioritize paying them off before other types of debt.
Now, if in your case revolving debts and secured/unsecured debts have interest rates in the same range (with variations of no more than 8% to 9%), this wouldn’t be as relevant.
What if I can’t afford it?
There are cases where debts are so high that a person's income is not enough to pay them off.
In these cases, it is difficult for the Snowball Method to work unless the person finds a way to increase their income and drastically reduce their expenses, at least temporarily. This includes asking for more hours at work, getting a second job, selling things that are not used, renting a room, etc.
If even after all this it is impossible, there are other alternatives that the person can consider, including debt relief programs, such as a Debt Management or Debt Settlement program. These types of programs can serve as a resource for those whose debts are simply impossible to pay. Each one works in a very specific way, and it is important to know the details and implications of each program before taking action.
There are no magic formulas and no one else but yourself can get you out of the problem. You must act and you must do it soon; otherwise, the problem will only get worse.
Conclusion: Free Yourself from Debt
Getting out of debt not only has a positive financial impact but also provides peace of mind and the ability to make better financial decisions in the future.
The Snowball Method is a truly effective strategy for freeing ourselves from debts. No matter how overwhelming they may seem, getting out of debt is the first step toward financial freedom, and this method can provide a clear and easy path to do so. The key is discipline and determination to follow the process.
