Debt Snowball
Debt is a shaky foundation for any household, especially one in which there is only one income. One of the first priorities to get your financial house in order is to get out of debt, especially consumer debt. Reduce spending wherever possible and then attack your debts one a time.
One of the best ways to attack debt is to create a debt snowball. This process is a focused way to attack your debts without affecting your cash flow. Here are the steps:
1. Put your debts in order by the lowest balance
2. Pay the minimum balance on each debt except the smallest one which you will attack with every penny you have
3. Continue this each month until the first debt is paid off
4. Once the first debt is paid off, apply the money you paid on the first debt to attack the second debt and continue with the minimum balance on all other debts
5. Once each debt is paid off continue applying that money towards attacking the next debt and paying the minimum balance on the others until all the debts are paid off
Some financial experts advise using attacking your debts by paying off the loans with the highest interest rates first. This will reduce the interest a consumer pays. Others, such as Dave Ramsey, argue that by starting with the lowest balances one gains a psychological power of completion to motivate them to pay off other debts. The personal finance blog getrichslowly.org wrote an excellent article that discusses the merits of each version of the debt snowball.
No matter how much or little you are able to pay off at first, employing this method will give you the power to pay off your debts and gain more financial freedom.
Here is an example of the debt snowball in action. Let’s say that Jane has a credit card balance of $1,000, a car loan that’s $2,000 and a student loan that’s $2,200. She has cut all extra expenses so that she can use $1,000 to pay down her debt each month.
Month 1:
Credit card $800
Car payment $100 (minimum payment)
Student loan $100 (minimum payment)
Month 2:
Credit card $200
Car payment $700
Student loan $100
Month 3:
Car payment $900
Student loan $100
Month 4:
Car payment $300
Student loan $700
Month 5:
Student loan $1,000
Month 6:
Student loan $200
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