Debt snowball

2 July2009

When it comes to getting out of debt, there are a range of methods and debt solutions that people can use to help them. One such method is known as the `debt snowball` - a method popular in America that has helped a lot of people address their debts.

How a `debt snowball` plan works

The debt snowball is a method of `do-it-yourself` debt management in which you will address your debts in order of size (starting with the smallest), rather than starting with the one with the highest interest rate. This means that you will start to clear a higher number of your individual debts in a shorter space of time.

The idea is that you will continue making the minimum payment on all of your debts, and make overpayments on the one you are focusing on at the time (i.e. your smallest remaining debt).

To illustrate this, let`s consider the following example of four credit card debts with minimum payments of £25 for each. (For the purposes of this article, this is a simplified example which does not take interest into account, and assumes that you will not be adding to your debts.)

  • DEBT A - £200
  • DEBT B - £400
  • DEBT C - £900
  • DEBT D - £2,000
  • Monthly income available: £200.

Assuming you can afford a minimum monthly payment of £25 for each debt, plus an overpayment of £25 per month (out of a possible £100), you will pay a total of £125 towards your debts every month, leaving you with £75 of disposable income.

To begin with, you`ll be paying £25 towards Debts B, C and D each month, and £50 towards A - meaning Debt A will take four months to pay off.

Once Debt A has been paid off, the £50 you have been putting towards it will effectively be free to put towards your other debts - meaning you can pay £75 per month towards Debt B, and £25 towards Debts C and D.

Once Debt B is paid off you`ll pay £100 towards Debt C and £25 towards D.

Once Debt C has been cleared, you`ll have the full £125 to put towards Debt D every month until it`s paid off.

This is not actually the fastest way of paying off your debts. It would be faster to pay off the debts with the highest interest rates first, meaning that these higher-interest debts have less time to grow. However, this might not give you the sense of satisfaction of seeing your debts `disappear` so quickly, like the debt snowball method can. This can really help you stay motivated.

What if I can`t afford my debt repayments?

If you can`t afford to make all of your minimum debt repayments, then the debt snowball method won`t work, as you will end up missing payments. In this case, a professional debt solution, such as a debt management plan or an IVA, for example, may be appropriate.

If you`re unsure, you should always speak with a professional debt adviser to discuss your options.

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Tags: debt, snowball, debt snowball, debt snowball method, debt management, what is the debt snowball, pay smallest debt first, Dave Ramsey

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