I know when I first started taking an interest in personal finance, one term I heard pop up frequently was that of the debt snowball. For those new to the concept, it is a debt paydown strategy, popularized by Dave Ramsey, where you pay down your debts in order from smallest to largest. This can be applied when you have one or more debt, and are able to afford to pay at least the minimum required payment. Utilizing this method, extra cash is allocated to paying debts with the smallest amount owed. After the smallest debt is paid off, you then move onto paying the next slightly larger small debt above that. Thus seeing the debts drop off one by one, gives you a psychological win as well.
However, there are some questions you might have about the method itself and want to dive in a little bit further. Read on for more.
1) Why should I pay the smallest debt first? Wouldn’t math say to pay the one with the highest interest rate first?
Certainly in most scenarios. However, the point of the debt snowball is all about changing your behavior. For example, if you go to pay off a student loan first since it’s the largest, you won’t see that depart your debt snowball train for quite some time. All you’ll see is your numbers going down in an Excel spreadsheet, but that’s about it. Soon, frustration will set in, you’ll stop paying extra, and lo and behold, that Old Navy card is still sitting there.
When that tiny small debt goes first though, you see progress. It’s gone and ka-put. Next thing you know, there goes the second debt, and the next one, and the next one, you get it. You’ll gain confidence, and will be more apt to stick to it.
2) I have a sweet ride that I’m making astronomical payments on. Should I sell it, or just pay it off to help my debt snowball?
Knowing when to sell something or pay it off, is something that definitely comes up frequently with vehicles. Generally there are two things to remember. One is if you need more than 24 months for paying off your car, it’s time to sell. Set a two-year goal and use that – rather than your loan schedule – to figure out what you need to do. Second is figure out how much of your net worth is put into your vehicle. If you reach the conclusion that it’s more than 50%, you are putting WAY too much into something that already drops in value and should be let go.
If you have other items like boats, rental properties or anything that isn’t your home – you can apply the same specifics. If it can’t be paid off quickly, or hacks too far into your income, sell baby sell!
Letting those payments loose from your life will greatly alter both your mindset and your wallet on your debt free journey. On the lighter side, if you own an item that’s due to be paid off in a few months, go ahead and keep it, just destroy that debt!
3) I always hear about the importance of saving for retirement and getting that company match. Should I keep contributing to my retirement while working on my debt snowball?
According to Dave’s seven baby steps, that’s a big no. All of your energy and resources should be geared toward getting out of debt while you’re on that step. If you’re focusing money toward retirement, that will only guarantee you’ll stay in debt longer. FOCUS on one thing at a time.
If you cut back on your lifestyle, extra income from a second job (if you happen to take one), and laser intensity, you’ll be out of debt in no time, and can establish your full emergency fund. Then, it’s right back at investing. Getting debt-free will more than make up for that little vacation from investing.
4) We have a little bundle of joy on the way. What should we do?
This topic is near and dear to us, since we just experienced this joy ourselves last summer! So, congratulations to you! There is no greater feeling! If your little one is on the way, just go ahead and stop the debt snowball for now, and saving up the cash. Keep on making your minimum payments of course, but sock away all the remaining money. That way, if an emergency happens or huge medical bills, then you’ll have the money for paying them.
That way, once your baby is home from the hospital and all is well with everyone else, then you can take that saved money, and resume applying it to your debt snowball.
5) What should I do about paying on my debts if I get laid off?
While one hopes this never happens, sadly it’s always a remote possibility. If this should happen to you, it’s all about survival mode. Make sure your lifestyle gets hacked down to the BASICS. Make those minimum payments, but nothing extra toward debt. Stop the snowball until work is found again (or get a side job or even freelance work until you get a full-time position with another employer).
If you obtain severance pay, don’t necessarily think of that as some windfall and try living off of that. Heck, try not to touch it at all. Live only a bare bones life style and hunt for work like mad. Then hopefully once that new job comes long, NOW that severance can look like a large bonus that can go toward your debt snowball.
In closing, hopefully this gives you a better idea of how the debt snowball works, and that you can be well on your way toward a new found sense of freedom. If you need help getting organized, I HIGHLY recommend the site, Undebt.it. It provides great tools in helping you get set up to be debt free, including providing that all important debt free date! See our previous post for more information about how it can help you.
Good luck! Feel free to leave comments below if you have any questions about getting started, or any tips you may wish to share with readers as well!