Saturday, July 31, 2010

Debt Snowball. What is it?

Image via Wikipedia
Image via Wikipedia
Frosty the Snowman (TV program)
This term "Debt Snowball" what does it mean, does it refer to when Frosty the Snowman went over his credit limit? I don't think so. Its a term made famous by financial guru Dave Ramsey. The way it works is first be current in all your debts. List all your debts from smallest to largest ignoring interest rate. Pay the minimums on all your debts except the smallest one. The smallest one pay the minimum and as much other money you can scrape up to pay it off as fast as possible. After the first debt is paid off take that amount and add it to the second debts minimum. Hence increasing the payment on the second debt. When that one is paid off, take all that money add it to the the third minimum debt payment. Keep doing this till you go thru all your debts. This plan allows you to focus an ever increasing amount of money on your smallest debt. Every time the debts are paid off the snowball payment keeps getting bigger ultimately getting you out of debt sooner.

The key to this plan is the focusing on the smallest debt for an emotional win. Even though other debts may be a higher interest rate. You may be thinking paying off the highest interest debt first would be mathematically correct. The emotional win is more valuable to the individual. To have a couple of wins under your belt is a ego boosting feeling. This gives you the encouragement to keep going. In my personal experience it the only thing that kept me going and still does. The tedium of going thru this process is exasperating. It takes a long time and is a lot of work. You could lose patience and chuck it all if you didn't have some early wins. It like when you go on a diet and exercise. If you don't see results you most likely give up.

The argument of paying higher interest debt first is mathematically correct. It seems the right way to go. But responsibility with money is more psychological than math related. If you did the math on using credit, you wouldn't us it. It goes along with impulsed purchasing. Did you ever want to purchase an item. Maybe something you were exposed to when you were walking down the isle of a store. You just grabbed an item and put it in your shopping cart. Your whole thought process consisted of: See item, like item, I have credit card, Buy it. Totally a Pavlov's dog reaction. Not more than 2 second thought process and programed response. Now if you had left that credit card at home and only had cash the entire event would of happened differently. Thought process would go something like this. See item, like item, I only have cash, Do I want to use my little bit of cash on this piece of junk. Answer, "No". Its not automatic, it actually takes longer to decide to purchase because using cash actually hurts. Using credit is fun and painless and can be rationalized easily. You actually buy more stuff when you use credit. 

Here is an example of the debt snowball in action:

My Debts listed smallest to largest:

  1. Home Depot - Balance 1214.00 - minimum 22.00 - Interest 15%
  2. Chase 1 - Balance 2858.00 - minimum 36.00 - Interest 2.9%
  3. Chase 2 - Balance 7076.00 - minimum 170.00 - Interest 16%


Here is the plan for paying off $11,148.00 of debt in 19 months. Its the plan I am going to follow. Of course if  I have any other extra money I will add it to the snowball. Again it will take discipline and focus to complete this. You must establish goals and make a written plan on how to complete them . The Debt Snowball is the best plan for getting out of debt. Some people have gone the way of "Debt Consolidation". Thats when you refinance all your bills into one amount and have one small affordable payment. This is not a plan for success. Its a lazy way of just moving your debt around and believing your actually doing something. Its a false economy to think that. Another way people pay back debt incorrectly is go to a credit consolidation company that takes charge of all your debt and renegotiates your balances and interest rates down. You end up paying them a large fee and wrecking your credit. Take charge of your debt, do this your self.

2 comments:

  1. Good luck! Making the excel chart shows you have discipline. If you can set the goal, you can achieve it!

    ReplyDelete
  2. Public debt grows each single day. To get out of debt it is necessary to cut expenses and focus on saving money. And our government does not cut any expenses. Living is very expensive and many consumers also live through money advances and credit cards. We used to think that in case we do not have something and do not have money to buy it then we can also rely on extra cash and probably get in debt. It often happens so.

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