If you have found yourself in debt, or you are exploring ways to get out of debt for someone else then there are a number of proven methods or techniques to enable you to approach the problem and have it paid off as fast as possible.
The other methods of paying down debt in this series consist of:
If you are interested in reading the forthcoming instalments in this series then please sign up to my mailing list using the sign up box to the right and I’ll drop you an email when they are published.
Each and every method is unique and your preferred method really comes down to personal choice.
The Debt Snowball Method
So what is the debt snowball?
The debt snowball method was devised by Dave Ramsey and centralises around increasing your ability to pay off debts in the same way that a snowball increases in size as you roll it around.
Dave Ramsey coined 7 baby steps to moving from a life of debt to one of saving and giving. These baby steps are as follows:
- Build a $1000 emergency fund
- Pay off all debt except for your house
- Build 3 – 6 months of expenses in savings
- Invest 15% of your income into retirement
- Create a college fund for your children
- Pay off your home early
- Build wealth and give
The debt snowball method sits within the second step.
The first step is focussed on creating an emergency fund. If you haven’t created an emergency fund yet then here’s a post on how to have fun saving a $1378 emergency fund over the course of a year.
Getting started with the debt snowball
To get started you need to make a list of all your debts and them from smallest to largest by the amount owed.
“Wait!” you say, “you don’t want me to list them by order of interest being paid on each debt?”
There’s a bit of science behind why the debt snowball method is so successful. A study showed that humans demonstrate increased motivation as they get closer to achieving a goal, well, ok it was rats in the study, but same difference.
If you’re interested in understanding a bit about the benefits of goal setting you can read more in my previous article about the benefits of setting goals.
In a nutshell, the neuroscience research behind the study identified that our brains use the neurotransmitter dopamine as an internal guidance system to help us reach goals. Dopamine is effectively the reward drug inside the brain. Dopamine signals were found to get stronger as a goal becomes closer to being achieved.
Clever stuff, huh?
The debt snowball method aims to have you kick the smaller debts from off the list so that you feel like you are getting somewhere fast.
It does not care whether the first or last debt is paying 4% or 24%, you are ordering by amount, with smallest amount first.
You will then arrange your budget to ensure the minimum payment is made off each individual debt. Whatever amount you have left over, to make additional payments, you put to use attacking the first debt at the top of the list (the one with the smallest balance). Attack that debt with the might of a hundred thousand migrating wildebeest.
Every single little cent you can find or save you pour into this single debt!
Once that debt is paid off you’re going to use the repayment amounts from the previous debt and combine it with the minimum payment for the next debt on the list.
You approach each debt on the list one by one with a compounding effect of minimum payment plus surplus, which is where the snowball analogy comes in.
Each time you pay off a debt and knock one off the list the amount you repay off each subsequent debt becomes greater.
In this way the debt snowball method helps you steamroll your way through your debts.
Back to the science in the debt snowball method
Just like the rats in the neuroscience study exhibited a release of dopamine (the happy chemical) in their brain as they got closer to their goals, so to does your brain.
You’ll feel a sense of achievement as you see the smaller debts falling off the list, this sense of self achievement will spur you on and subconsciously you’ll start working harder to pay off debts more quickly.
I found myself unknowingly doing the same thing when I paid of $5000 of debt in a credit card in just 6 weeks.
As I began to achieve my goal of paying off the debt and, more importantly, saw that I was going to achieve it faster than I had anticipated I cut back on more expenses and lived incredibly frugally for a period of time.
These bolstered efforts spurred me along to achieve my goal far faster than I had expected.
If you take a look at the following example that was laid out by Dave Ramsey, he puts forward these fictitious debts in an ordered list as required. The minimum payment due each month is in brackets:
$500 medical bill ($50 payment)
$2,500 credit card debt ($63 payment)
$7,000 car loan ($135 payment)
$10,000 student loan ($96 payment)
In this example we’re going to assume you can just about make the minimum payment and cover your living costs with your salary.
However, you manage to get a second job, and you start living frugally which frees up an additional $500 a month.
Mr Ramsey suggests that finding a way to earn this amount of extra income is very doable, and I agree.
You then go hard out on paying down those debts!
In your first month you pay off the medical bill because you’ve got an extra $500.
The second month, you take the $50 payment you would have been paying to the medical bill, add it to your extra $500 and the $63 minimum payment for the credit card, and you start attacking that. That’s $613 toward that second debt.
After just 4 months your credit card is paid off!
You then start to kick that car loan to the curb.
You have the $613 you were paying each month to the credit card plus the $135 you were paying for the car loan.
That’s a total of $748 each month.
By this point, 5 months has gone by, so your car loan debt should be around $6,325 which is the balance of $7,000 less 5 months at $135. So, you should have this car loan paid off in 9 months time.
You see how you’re picking up pace?
In just over a year, 14 months if we’re being more precise, you’re down to one single debt thanks to the debt snowball method!
If this were me, the competitive streak in me would kick in around 9 months and I’d reset my goal to try to achieve that milestone by month 12, effectively shaving 2 months off.
I would probably have done this by cutting back even more on living expenses, working more hours in the second job or perhaps asking for a pay rise in my main job.
Whatever you can do to bolster your efforts, do it; push yourself!
When you arrive at that student loan you should be down to a balance on that loan of around $9,000 and you’ll have a whopping $844 per month to hammer away at it.
That’s going to get paid off within about 11 months.
Even without pushing yourself to reach your goals faster you can pay off $20,000 of debt in 24 months by using the debt snowball.
That’s pretty incredible!
The debt snowball is effective because it modifies our behaviour.
If you were to think of paying these debts off in reverse, say for arguments sake because the student loan had the highest amount of interest, you’d lose heart.
You’d stick to the minimum payments and well you only need to do the simple math on the student loans to know that’s going to take 100 months to pay that off!
100 months for one debt, compared to 24 for them all!
So by kicking the small debt off your list in the first month you see progress. The second debt follows pretty quickly and realization sets in that this is working. When that happens you’ll stick to the plan and will eventually pay off debt and become debt-free, hopefully forever.
Here’s hoping you give the debt snowball a shot. Let me know what you think in the comments.