Debt Snowball Method of Debt Repayment

The debt snowball method of debt repayment is a way for households to eliminate their debt while providing quick results and motivation to continue with the debt reduction plan. The basic strategy is to put any extra debt payments into your lowest balance account first. Although it is commonly recommended to pay your highest interest accounts first, this method may help you stay focused on your debt management plan due to the fact that within a short period of time your smallest balances are generally paid out and less monthly bills are coming into the household.

A few things to note before we go too far into this debt reduction solution...

  • This solution will not work for everyone, and is not recommended if you are struggling to make your minimum payments. If you are struggling with making your minimum payments every month please contact us for a free no-obligation consultation
  • Debt Repayment should not be put ahead of retirement savings
  • Difficulties arise in repaying debt if you are actively using your credit cards and increasing the balances.

How to start when considering the debt snowball method:

  1. List all your debts in ascending order, starting with the lowest balance first
  2. Add to the list the monthly minimum payments on all the accounts
  3. Commit to making the minimum payment on every account every month. It's impossible to repay accounts if they are falling into the arrears

You should get a listing that looks something like this:

Account / Debt Balance Minimum Payment
Credit Card 1 $ 750.00 $ 25.00
Credit Card 2 $ 1,850.00 $ 60.00
Car Loan $ 4,200.00 $ 200.00
Personal Line of Credit $ 12,800.00 $ 150.00
Totals: $ 19,600.00 $ 435.00
  1. Consider your monthly budget, How much extra do you have to put towards your debts? Lets use $75 monthly for this example
  2. As you are paying the accounts this month, pay all your minimums and add the extra debt reduction money to your smallest balance account. (Making the payment on Credit Card 1 $100 instead of the $25 minimum payment.) Note: Some lenders will utilize 'extra' money paid to offset your next month's payment - be sure to follow up with the creditor and make sure that the extra amount you paid was applied directly to the balance.
  3. As months go by you will find that your smallest balance account should be paid quickly, consider if it's a balance of $750 and you were contributing an extra $75 per month over the minimum payment - within 10 months the account is paid in full.
  4. Once that smallest balance is paid, use the $25 minimum payment for Credit Card #1, and now that the account is paid, apply that minimum and the 'extra' debt reduction money ($75) to your next smallest balance account. Adding an extra $ 100.00 over the minimum payment required.
  5. You will find that instead of paying just $75 extra towards the account, you are paying even more towards discharging the balance by adding the money you were paying towards the smallest balance account's minimum payment.

The fact that the amount you are adding to your payment to reduce the balances keeps increasing is where this program gets it's name, similar to a snowball rolling down a hill - it gains more snow, likewise your debt reduction payment snowballs as you pay off the smaller balance accounts. Applying a larger debt reduction payment (consisting of the minimum payments you budgeted for on the now 'paid' accounts) to a higher balance account will allow you to discharge that balance faster.

Other Opinions regarding this Debt Repayment Strategy...

According to financial experts, many suggest paying off higher interest accounts first in an effort to reduce the amount of interest you are being charged. Although it's a valid argument supported by 'math' there is another argument in favour of paying the smallest account balances first.

Financial management is 20% knowledge and 80% discipline to get the job done.

Questions to ask yourself:

  • Can you truly balance your budget and stick to it?
  • Can you distinguish between a necessity and a 'want' at time of purchase?
  • Will you be able to stop using your credit cards and live on the 'cash' income that you clear after taxes?
  • What happens in the event of something unexpected? Have you planned for the occasional setbacks that are unavoidable in your budget?
  • Are you saving 5% of your income - just in case ?

If you answered 'yes' to all of the above questions then the debt-snowball method of debt repayment may be for you. The fast repayment of smaller balance accounts and fewer monthly bills being delivered to your home should provide the added motivation to stick with the program. Once you see the payments increasing to your other accounts and how fast the balances are dropping from statement to statement should also keep you motivated to continue the repayment plan.

What if you have more small balance accounts than in the above example? You will see results even faster! Say your financial position looked something like this:

Account / Debt Balance Minimum Payment
Credit Card 1 $ 450.00 $ 25.00
Credit Card 2 $ 550.00 $ 30.00
Credit Card 3 $ 650.00 $ 35.00
Car Loan $ 4,200.00 $ 200.00
Personal Line of Credit $ 12,800.00 $ 150.00
Totals: $ 18,650.00 $ 440.00
Paying an extra $75 monthly over your minimum payments will pay in full Credit card #1 within 6 months, Credit Card #2 within the following 5 months, and Credit card #3 within the following 5 months. So within a total of 16 months of following this debt repayment strategy, 3 of your 5 creditors are paid in full and you have only 2 monthly debt payment bills coming in and your car loan balance will be down around $1,000.
After some Quick math - based on the 3 credit card example above, as a customer you have paid in full $1,650.00 in debt by adding only 16 payments of $75 above your minimum debt payments. So by contributing $1,200.00 in extra debt reduction payments you managed to pay back $1,650 in interest-accumulating debts.
  • Would you find that to be a motivation to continue?
  • Would you be motivated if after only a few months of sticking to your budget you have cleared one debt - PAID IN FULL - and started repaying the second one?
  • Will seeing your owing balance drop on every statement that you receive motivate you to continue the program?

For this reason, the quick repayment and reduction of monthly payments due to your creditors, the debt snowball method of debt repayment can keep you on the track to financial success and an end to debt.

Continuing the above example...By the end of 2 years you would be adding an additional $165 over the minimum payment towards your car loan, and once that is paid (a matter of months) you would have the $200 budgeted car payment to apply to the credit line account (plus the $165 monthly you were paying as your debt snowball payment) making your payments to the credit line $365 monthly over the minimum payment. So, without spending anything on your cards, and adding only $75 monthly to your debt repayment you would have paid back $1,650 on 3 credit cards, four thousand on your car loan, and your snowball debt payment would be of a sufficient amount to start reducing the credit line balance by approximately $365 monthly over the minimum payment (Reducing the balance almost $4,400 within the first year of accelerated payments.)

When you get to this stage it may be prudent to speak with a financial planner about how to better utilize the monthly debt servicing funds to increase your retirement portfolio for the future.

Cautions regarding the Debt Snowball method of Debt Repayment...

If you are experiencing hardship making your minimum payments, or you are just scraping by from paycheque to paycheque then this method is likely NOT in your best interests. In the event of loss of income, or further financial hardship, creditors that were paid the minimums only while others were paid off will have reason to decline insolvency proceedings, and could cause you to not qualify if the worst were to happen. There are allowances in bankruptcy law that do not allow for only certain creditors to be paid while others are 'written off.' The concept of 'preferential payments' could require that the amount you would be required to pay back in a Consumer Proposal or Bankruptcy to skyrocket. And in the case of an insolvency where you can't afford the payments the Trustee may require that assets such as home, car, or retirement savings be liquidated and the proceeds paid to your creditors.

If you are considering this method of debt repayment - please give us a call for a free, informative, private and confidential consultation with a licensed debt professional. In a brief conversation we will be able to possibly identify other methods that you may find provide better reductions of your balances in a shorter period of time. The best way to improve your credit is to pay your accounts as quickly as possible in a way acceptable to both you and the creditors.

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