Popularized by finance expert Dave Ramsey, the debt snowball method is one of the effective ways to eliminate all debt and manage your finances better. This solution can be used to erase all types of credit, except mortgages. It is about starting small and building momentum, which is something we abide by at ApnaPaisa.
Initially, you focus on paying off your smallest debt first while making payments toward your other debts. Once you have cleared these dues, you repay the next smallest balance. This is how you build or ‘snowball’. Although, in the process, you may not be able to save money on interest but think of this as a disciplined way to clear off your debt.
How to get the debt snowball rolling for you?
If you are looking to commit to the snowball method for your debt, follow these four steps:
Prepare a list of all your outstanding loans and credit card dues. Now sort them in order from smallest to largest outstanding balance.
However, do not include your mortgage here. Mortgage payments and amounts tend to be huge while the rates of interest are low.
Prioritize paying off the smallest one with as much cash as you can, regardless of its interest rate. At the same time, pay the minimum amount on each balance.
For instance, if your smallest debt amounts to INR 6,000 every month but you have saved a surplus of INR 6,000 in your budget for debt reduction. It makes sense to add the two amounts to make a monthly INR 12,000 payment on your smallest debt.
Do ensure you create a comprehensive budget that takes care of all your financial needs, including eliminating your debt.
After paying off the smallest balance, allocate your money towards the next smallest debt as outlined in Step 1 above. So, you can assign INR 12,000 to the next debt in your list or distribute it as minimum monthly payments across your outstanding loans and credit cards.
Do continue making the minimum payments on the remaining debts.
Repeat this cycle till you are completely debt-free.
To illustrate this better, consider the following example. Let us say you have the following loans and credit cards debt:
|Debt||Balance||Interest Rate (annualized)||Monthly Minimum|
|Credit Card||INR 45,000||52.00%||INR 2,500|
|Personal Loan||INR 75,000||10.50%||INR 3,710|
|Car Loan||INR 1,00,000||7.00%||INR 4,477|
|Home Loan||INR 10,00,000||8.60%||INR 14,444|
In the above example, you should handle the credit card outstanding dues, since it is the smallest amount in the list. You would pay the minimum payment of INR 2,500 every month, along with any extra money you can assign for this repayment. Let us assume the amount is INR 3,000. Thus, you would pay a total of INR 5,500 each month for Credit Card, while clearing off the minimums due on the other three debt accounts. If you follow this schedule, you can eliminate your first credit card dues in eight months.
After the credit card debt is cleared off, you’d move to the personal loan debt, the car loan debt and finally, the home loan debt. Now for this, you have already allocated INR 5,500, which was used to pay off the dues on your credit card.
With the snowball method, you only focus on the smallest debt you can pay off first. Additionally, the repayment tenure is only used to calculate the EMIs or monthly minimum. We are not considering that when allocating funds. More so, the interest rates are annualized in the above example.
The Snowball Method is a fantastic way to get rid of all your outstanding credit cards and loan dues. You can follow the four steps to get started with your debt and overall financial management. Make sure your monthly budget supports your expenses and investments.