Debt Snowball Principle

Imagine yourself playing in the snow on the side of a hill. You make a small ball the size of a tennis ball and roll it down the hill. By the time the ball gets to the bottom it should of grown bigger because it collects more layers of snow just like on Tom and Jerry.

Dave Ramsey made this term popular and so far it’s worked for me.

This principal can be applied to you personal finances too. By this I mean you start small, you take that extra 50 bucks and pay it into your credit card or store account that’s getting larger due to interest charges. How will the 50 bucks make a difference to an amount that looks like it will never come down?

Imagine you have 3 accounts that are various amounts and different interest rates.

1.       Susan’s Shoe Mecca – Outstanding balance: 1000 Interest rate 10% (minimum payment: 80)

2.       Mikes Hardware –        Outstanding balance: 2600 Interest rate 8%   (minimum payment: 60)

3.       Your credit card –        Outstanding balance: 4000 interest rate 13% (minimum payment: 110)

Looking at the list which would you pay off first?

Logic tells you that number 3 is the most expensive and that will need to be paid off first. That’s a wise move and probably the most correct one. But after 3 months of paying the min payment along with the extra 50, you become despondent because it looks like it will never end. You might even stop paying in the extra money all together.

My advice (This is what I have done personally) eliminate account 1 first. You will be able to pay it off quicker and stay motivated to pay down the rest of the accounts. Then tackle number 2 then number 3. So how does the snowball effect work for the above?

You still the minimum on all the accounts as per normal but you select an account you going to pay in extra. So for me it was account 1, I pay the minimum of (80) +50=130. I continue paying this amount until the account is paid up. Then for account 2, I pay the minimum (60) plus the extra 50 plus the minimum payment of 80 from account 1. So it will be (60) +130=190 that gets paid every month. Then when account 2 is settled and all that is left is account 3 you do the same, (110) +190=300.

By doing it this way you save extra charges on the interest because you pay more than the minimum. After each account is settled don’t make the mistake of spending that extra cash, all that this exercise is really costing you is the extra 50 each month. Pretend you still have to pay the minimum even after the account is closed, and sooner than you think you would have eliminated all 3 accounts.

I have put this into practice and eliminated 2 credit cards and 2 store accounts this way. It does take patience, time and perseverance. If you have done this before or have a different approach, please feel free to leave a comment below.