Over the last couple years we’ve managed to pay off thousands of dollars in debt, in a variety of forms.
Initially, we set out on a path of paying off debt by working on the debt with the highest interest rate. That was, until I met Dave Ramsey at a Live Event and he forever changed the way I thought about debt reduction.
The Debt Snowball
What is the Debt Snowball plan recommended by Dave Ramsey?
It is a debt reduction plan that works because it takes human nature into account, rather than relying on mathematics alone.
Once a family has a written budget and a small emergency fund, they begin the “snowball” by listing all their debts in order from smallest outstanding principal balance to largest.
Any extra money after essentials are paid for the month goes toward paying down the smallest debt.
Once this smallest debt is paid in full, the next smallest debt is targeted. Each debt paid off means a monthly payment has been eliminated.
The money that went toward that payment can then be applied to the current targeted debt.
Like a snowball moving downhill, this method gains momentum with each small success until the debtor is no longer in debt.
What About Interest Rates?
Those who have studied finance, accounting, or mathematics will notice that the Dave Ramsey method does not take into account the various interest rates on the debts.
Mathematically speaking, it would seem more sensible to list the outstanding debts from the one carrying the highest interest rate to the one with the lowest rate.
Compound interest is a formidable force for good or evil, and this mathematical debt reduction plan would seem to be a wiser course of action.
If a Vulcan were in debt, he or she would most certainly use the mathematical approach and logically eliminate the highest interest rates first; however, let us assume the person in debt is a human and lives on Earth.
Humans who bury themselves in consumer debt do not have a purely mathematical problem; they have a behavior problem, too.
People need incentive and encouragement in order to make major changes in their behavior. The snowball method enables debtors to experience small successes quickly.
Each small success gives a person hope that there really is light at the end of the tunnel.
Many who are deeply in debt have been demoralized by job loss, medical bills, messy divorce, or embarrassment about their compulsive spending habits. In order to sustain the effort and discipline required by a debt reduction plan, a person needs fuel; the act of crossing a debt off the list provides fuel.
Success breeds success; this is why the Debt Snowball is such a powerful tool for eliminating debt.
Exceptions to the “Smallest to Largest” Debt Method of Repayment
The mathematical method does have its place. For example, a debt such as a “payday loan” may have such an outrageous interest rate that it should be placed at the top of the elimination list.
Once that major financial mistake is history, the resulting peace of mind should boost anyone’s spirits and keep the ball rolling.
Another exception to the “smallest to largest” rule of thumb may be debts owed to the Internal Revenue Service or other scary creditors.
Sometimes peace of mind from eliminating a particularly worrisome creditor is more important than the size of an outstanding principal balance or interest rate.
You may also have “personal” debts that you consider a more pressing repayment priority than a Visa card. A loan from the in-laws comes to mind, for example.
Paying off these personal debts fits in with the Debt Tsunami method of debt reduction, which emphasizes paying off your debts “in order of their emotional impact.”
Where Are We in the Debt Snowball?
We just recently made our last payment on my truck, and have already managed to knock off over $10,000 in credit card debt.
As we are working on the remaining Dave Ramsey Baby Steps, we are also making extra payments on our mortgage. We have a goal to pay off our mortgage early to become 100% debt free and free up future cash flow.
There is more than one way to become free from debt. Success is most likely if debtors uses a plan that is simple and keeps them motivated.
The Debt Snowball met both criteria for us, and I suspect it will most others who find themselves deep in debt.
Be sure to check out the rest of our series, How to Get Out of Credit Card Debt