Managing multiple debts with varying interest rates can be challenging. The Debt Snowball Method is a debt repayment strategy that simplifies repayment and provides psychological motivation to settle debt quickly. This blog aims to explain the snowball effect, trace the roots of the Debt Snowball Method, demonstrate the snowball formula, illustrate its functionality, and highlight its advantages and limitations.
What is the Snowball Effect?
A snowball grows as it rolls down a snowy slope, gathering more snow. The phenomenon is commonly called the snowball effect.
In debt repayment, the snowball effect refers to how settling smaller debts can build momentum and motivation to tackle larger debts. As you eliminate smaller debts one by one, the freed-up cash flow can be applied to larger debts, creating a snowball effect that helps you gain financial traction.
What Is the Snowball Method?
The Debt Snowball Method is a helpful approach to paying off debt. It involves prioritising debts with smaller balances and paying them off first, regardless of their interest rates. The main goal is to concentrate on the smallest debt initially and then apply the payment amount for that debt to handle the next smallest debt, and this progression continues until all debts are paid off in full.
Who came up with the snowball method?
Financial guru Dave Ramsey popularised the Debt Snowball Method. Although he didn’t invent the concept, he popularised it through his radio show, books, and financial courses. Dave Ramsey’s “The Total Money Makeover”, published in 2003, explained this method in detail, and since then, it has gained recognition.
Why is it called the snowball method?
The “Snowball Method” derives its name from the snowball effect as it commences with small steps and progressively gains momentum as it advances. As you pay off each smaller debt, you roll the payment amount into the next debt, just like a snowball grows as it moves downhill.
What is the snowball formula?
The Debt Snowball Method doesn’t involve complex mathematical formulas. Here are the steps:
- Arrange your debts from the smallest balance to the largest in ascending order.
- Make the minimum payments on all debts.
- Allocate any extra money you have in your budget to the smallest debt.
- After paying off the smallest debt, apply this process to pay off the next smallest debt.
- Repeat this same process until you’ve settled all debts.
How does the snowball method work?
The Debt Snowball Method relies on behavioural psychology to motivate you throughout your debt repayment journey. By starting with the smallest debt, you experience quick wins and a sense of accomplishment sooner. This positive reinforcement encourages you to continue the process and gain momentum as you progress to more substantial debts.
What is an example of the snowball method?
Let’s consider an example of how the Debt Snowball Method works:
Debts:
- Credit Card A: ₹10,000
- Personal Loan B: ₹35,000
- Car Loan C: ₹80,000
- Student Loan D: ₹150,000
Minimum Payments:
- Credit Card A: ₹500
- Personal Loan B: ₹1,000
- Car Loan C: ₹2,000
- Student Loan D: ₹3,000
Extra Payment Budget: ₹3,000
Using the Debt Snowball Method, you’ll begin by paying off Credit Card A first. Allocate ₹3,500 monthly to settle “Credit Card A” (₹500 minimum + ₹3,000 extra).
Once “Credit Card A” is paid off, you will focus on “Personal Loan B”. Allocate ₹4,500 monthly to settle “Personal Loan B” (₹1,000 minimum + ₹3,500 extra). Repeat this same process until you’ve paid all debts.
Why Does the Debt Snowball Method Work?
The Debt Snowball Method works because it addresses the behavioural and psychological aspects of debt repayment. Focusing on small wins gives you a sense of accomplishment. This makes staying on track and committed to your debt repayment journey easier.
Why is the snowball method Good? / Pros of the Snowball Method
The Debt Snowball Method has several advantages:
- Easy to Start: It doesn’t require complex calculations or financial expertise.
- Psychological Motivation: Rapid achievements build positive momentum and inspire to keep reducing debts.
- Progress Tracking: You can easily track your progress as debts are paid off from the smallest balance to the largest in ascending order.
Cons of the Snowball Method
- Interest Costs: Ignoring the interest outflows of any loan, you may end up paying a higher amount in interest.
- Longer Repayment: In some cases, the Debt Snowball Method may take longer to pay off debts than more interest-focused methods.
- Not Mathematically Optimal: From a purely financial standpoint, the Debt Snowball Method may not be the most efficient in interest savings.
Final Words
The Debt Snowball Method is a powerful debt repayment strategy combining behavioural motivation and systematic progress. This method may not be mathematically optimal from an interest-saving point of view. However, its simple application makes it attractive for individuals seeking to settle all outstanding debts.
Choosing between the Debt Snowball Method and other strategies depends on your financial goals and personal preferences.