It is common to have a lot of different types of debt, such as student loans, credit card debt, and car payments. The average American carries about $40,000 in personal debt, not including any home mortgages.
In 2018, nearly 70% of all college students took out student loans to help pay for school, borrowing an average of close to $30,000.
One method for getting a handle on your debt is to use the snowball method. This can help you minimize the number of loans you have by paying down the smallest debt first in an effort to eliminate it faster. This can be very satisfying and help you feel accomplished.
The debt snowball method may not save you the most money, however, as it does not address your highest interest rate loans or debt first. Instead, it prioritizes the smallest debt.
If crossing things off a list helps you stay motivated, the debt snowball method could be a good strategy for you.
Understanding the Debt Snowball Method
The debt snowball method for paying down debt is a form of debt repayment that can make you feel like you are making progress on your debt by paying off the smallest loans first. It works by giving you the motivation to keep going as the number of loans you have begins to decrease. Here’s how it works:
- Write down all of your debt (student loans, car loans, personal loans, and credit card debt) and put your debts in order from smallest to largest
- Come up with a budget that frees up extra money
- Pay the minimum monthly payment on all your debts except for the smallest one
- Put as much money toward your smallest debt as you can each month until you pay it off
- Move on to the next smallest debt, and continue this process until you are debt-free
According to Dave Ramsey, this method works like a snowball rolling downhill. As you pay off your smallest debts, you will start to free up more money to keep paying off more debts. This can create good money management habits.
When to Use the Debt Snowball Strategy
The debt snowball method can provide you with some quick wins and help you feel like you are being successful in paying down your debt. It can show your progress quicker than the debt avalanche method, which attacks the debt with the highest interest rate first.
An example can look like this:
You owe $5,000 on credit card No. 1, $2,000 on credit card No. 2, $15,000 on your car loan, and $20,000 on your student loan. You will make the minimum payments each month on credit card No. 1, your car, and your student loans while prioritizing credit card No. 2. Pay as much as you can each month on credit card No. 2 until the debt is resolved. Then, move on to credit card No. 1 and pay it off. Next, pay off your car loan, and, finally, pay off your student loan.
It can seem counterproductive to not go after the highest interest rate debt first, but the debt avalanche method is a long-term strategy that can be difficult to stick to, as big debts like student loans take years to pay off. The debt snowball method has you pay off your smallest debt first, regardless of its interest rate, so you can see progress toward eliminating it.
Drawbacks of this Method
To use either the debt snowball or the debt avalanche method to pay off your debts, you will need to have disposable money beyond your minimum payment amounts each month. Both of these methods require that you put extra money toward one of your loans.
While the debt snowball method can help you get a handle on money management by giving you the confidence that you can effectively pay down your debt, it may not save you the most money.
Since the debt avalanche method has you make the biggest payments toward your highest interest rate loans, it can save you the most money overall – if you can stick with it long term. By paying off your highest interest rate loans first, you will pay the least amount of extra money in interest over time.
The debt avalanche strategy only works if you can ride it out until all of your loans are paid off, which can take years. The debt snowball method can feel more immediately gratifying.
Effectively Paying Off Your Debt
To protect your credit score and pay off your debt in a timely fashion, you first need to decide which strategy will work best for you. If you are someone who needs help staying interested, the debt snowball method can be highly effective.
You can use the debt snowball method for all kinds of loans and debts, from student loans to credit card debt. You just need to make a note of all your debts, come up with a workable budget, and stick to a plan to pay it all off.
Other methods of paying off debt include:
- Flexible repayment plans
- Debt consolidation
- Refinancing your loans
- Loan forgiveness programs
Your student loan servicer is a great resource for helping you to make your monthly payments manageable and working with you to pay down your loans. The faster you can pay them off, the less you will ultimately pay in the end.
Student Loans vs. Credit Card Debt
Student loans are considered installment credit, while credit cards are based on revolving credit.
With an installment credit loan, you borrow all the money in one lump sum and then have fixed monthly payments over a set amount of time to pay it back. Revolving credit, such as a credit card, allows you to keep borrowing what you need up to a certain credit limit. This can mean that your monthly payments change from month to month based on what you borrow.
If you decide to pay more than your monthly payment on an installment credit loan each month, be sure to let your loan servicer know that you wish to apply the extra amount to your principal loan amount rather than the interest. This can help you pay down your loan faster and pay less interest over the life of your loan term. Making larger payments on a revolving loan increases the amount you can borrow and also detracts from the amount of interest you will pay over time.
The debt snowball method can help you to stay motivated in paying off your debt while teaching you smart money management. However, if you can commit to the debt avalanche method, you can save more money overall.