Snowball Method to Eliminate Credit Card Debt
|August 15, 2006||Posted by derek under Credit Cards, Debt Reduction|
Imagine what happens to a snowball as it rolls down a mountain. Are you picturing that snowball rolling down the mountain, getting larger and larger as it increases speed? Well, that is the idea behind the snowball method to eliminate credit card debt and other forms of consumer debt.
The first step in the snowball method of eliminating debt is to write down all of your debts in order based on the interest rate. The important information to write down is the current interest rate, overall balance and the minimum payment required. Once you have this list of information, assign each debt a ranking based on the interest rate. The debt with the highest interest rate will receive the highest ranking. In the event that you have more than one debt with the same interest rate, assign the debt with the lowest balance the highest ranking.
The rankings assigned to each debt will be the order in which you focus on your overall debt reduction using the snowball method. The trick to the snowball method is that there is a predetermined amount of money available for debt reduction on a monthly basis, which will be divided up among all of the debts on your list. Each debt on the list will receive the absolute minimum payment on a monthly basis. The debt with the highest ranking, which also means the highest interest rate, will receive the minimum payment plus all additional funds that have been set aside for debt reduction. The amount available for debt reduction will be determined by your personal budget. If you do not have a budget at this point, it is highly recommended to take the time to develop a personal budget or spending plan as it will make it much easier to implement the snowball method.
Once the debt with the highest rate has been eliminated, you roll that payment into the minimum payment being paid to the next highest interest rate. Thus your main payment continues to grow, or snowball, as you eliminate the debt. Similar to the snowball rolling down the mountain, your snowball payment continues to get larger and larger and eliminates more and more debt as time passes.
Here is a brief example to help illustrate the concept. If you have three credit cards with the following details, assume you have $800 each month to apply to debt repayment:
Card Rate Balance Min Payment Actual Payment ========================================================= Chase 17.9% $3000 $ 90.00 $350.00 Citibank 14.9% $8000 $240.00 $240.00 Discover 9.9% $7000 $210.00 $210.00
Now, once the Chase credit card is paid off, you roll the $350 payment into the $240 minimum payment going towards the Citibank credit card, resulting in an overall payment of $590 to Citibank and the $210 minimum still being paid to Discover.
Card Rate Balance Min Payment Actual Payment ========================================================= Chase 17.9% $0 $ 0.00 $ 0.00 Citibank 14.9% $8000 $240.00 $590.00 Discover 9.9% $7000 $210.00 $210.00
While this is a very basic example, it does help illustrate the point of how powerful the snowball method can be to eliminate credit card debt. When coupled with the leverage of low-rate balance transfers, the snowball method is an outstanding tool for debt reduction.
As an added bonus, you might want to reference the snowball calculator as it will allow you to test difference scenarios and let you see exactly how long it will take to eliminate debt and how much interest it will cost. In addition, one really nice feature is the ability to input teaser rates and see how that can impact your overall debt strategy. Note: This is an Microsoft Excel spreadsheet. If you do not have Excel, you may want to investigate OpenOffice.org.
Notes and Additional Information
While ordering your debt by interest rate will result in the least amount of interest paid over the life of the debt, some people prefer to take a different approach. One common alternative is to pay the debts with smaller balances first as it provides a mental reward for eliminating some of the debt. Another alternative is to pay the debt with the largest minimum payment first, maybe a car loan, as that will likely free up the largest minimum payment to be applied to the next debt and increase the size of your snowball payment.
Basically, it boils down to formulating a plan that will work the best for you and your personality. One of the most important aspects of any debt reduction strategy is to create a plan that you will be comfortable implementing.
For answers to any specific questions about this approach or assistance with the creation of an individual debt reduction strategy, please comment below.