In previous posts, I wrote about the steps we followed to get our finances under control and ultimately, get out of debt. My post How do you get your finances under control, I review the five steps we used during our get out of debt journey. In one of my other posts, How much time do you spend budgeting, I dive into my detail regarding tracking all of your expenses, developing a budget, and looking for ways to find savings in your budget. In this post, I want to examine the debt snowball. Specifically:
- What is the debt snowball or debt avalanche and how does it work?
- How I used the debt snowball
- How can you create a debt snowball plan? I embedded a youtube video to show an example.
What is the debt snowball?
Here is how the debt snowball works. First, you write down all of your debts and their minimum payments. Next, you take the extra money you found during developing your game plan and apply that toward the first debt you want to pay off. Once you have paid off that first debt, you take that money and apply it to your next debt. You continue this pattern until all of your debts are paid off.
Here is a quick example: you have two debts; debt one has a monthly payment of $500/month and debt two has a monthly payment of $300/month. In addition, you found $200/month you can apply toward your debt because you tightened up your budget. Therefore, you are now paying $700/month toward debt one and you are still paying $300/month toward debt two. Once you pay off debt one, you apply the $700/month toward debt two. Now you are paying $1,000/month toward debt two!
A common question is: Do I start with my largest balance, smallest balance or my highest interest rate first? There are different arguments regarding which balance to start with – my take is to do what you think is best for your situation. The common argument for starting with the smallest balance is that you get a quick “win” and start to pick up momentum. If you start with the largest balance, you are likely saving yourself the most in interest payments. Interest payments are like taking money out of your wallet and putting into the garbage, so my philosophy was to knock out the debt that was costing me the most. This isn’t always the debt with the largest balance – you need to factor in what your interest rate is.
How I used the debt snowball?
Below is a snapshot of the original debt snowball plan I set up. The column on the far right, extra payment, displays an amount of $736. This is the amount we were able to save after analyzing our finances closely and creating a more efficient budget. If you run the math to see how long it would take us to pay off all of these debts you will quickly see that it would take longer than a year. If you read my post where I reveal that we paid off $97k in less than a year you are probably asking yourself something doesn’t make sense?
First, my wife and I had a sizeable emergency fund, and we liquidated some of the money in that fund to knock out most of the car loans. Second, we inherited some money that could only be used for certain expenses – student debt being one them. We are extremely blessed with the money we received from the inheritance. Finally, we took bonus money from our jobs and put it toward debt.
The concept is fairly simple; however, as with all financial plans, they require discipline to stay on track. I understand that unexpected events come up, which is why I recommend building an emergency fund before setting up a debt snowball.
How can you create a debt snowball plan?
I used excel to setup my debt snowball plan. I followed this simple tutorial to set up an amortization schedule to see when we would be able to pay off all of our debt. You simply set up a new schedule for each loan that you have. If anyone wants to see my example or if you want me to put together a custom debt snowball for your situation, please let me know! You can contact me at email@example.com.
Additionally, I found this youtube video that explains how Sarah used the debt snowball to stay motivated.