By: Timothy Ng
The longer you stay in debt the harder it becomes to escape from. Everybody is looking for the best strategies for paying off debts as fast as possible, and there are a number of different theories on which method works the best.
One of the most popular methods used by people to clear their debts is the “Snowball strategy” as championed by financial expert Dave Ramsey. Let’s take a look at his innovative debt solution, and see how it compares to other methods out there.
What Is the Debt Snowball Strategy?
When you want to roll a large snowball what do you do? You get a small handful of snow and begin to roll it around on the ground. As more snow begins to stick to the little ball it begins to grow, until after a period of rolling the ball around in the snow it becomes a large ball. So what does this have to do with paying off your debt?
The very basic idea behind the “Snowball strategy” is that you pay your smallest debts off first and work your way up to the biggest debts. This may go against most of the advice you have heard in regards to debt management, but let’s have a closer look at how this works.
Let’s say you have 3 credit card debts. The first card has $2000 outstanding, the second has $5000 outstanding, and the third has $9000 outstanding. What you do is pay the minimum payments on all 3 debts (again this will go against the majority of the advice out there), and any spare money you have at the end of the month goes towards the smallest debt.
Before long the smallest card with the $2000 debt is paid off. Now what you do is look at what the minimum payment was on that now cleared card, and apply that payment to the second card with the $5000 debt. You are now paying the minimum payment on the remaining two cards, plus what you were paying on the $2000 each month towards the next lowest debt; ie- the card with $5000 outstanding.
Once that second card is paid off you do exactly the same, with the minimum payment of the most recently cleared card going towards the last debt ($9,000). What is effectively happening is that each time you pay off one of the debts in full, the amount that you pay towards your next debt increases, allowing you to clear the debt faster.
Why Does It Work?
The thinking behind the system, is that debt problems are mostly dealt with in the head, rather than in the wallet. The “Snowball system” allows you to get rid of smaller debts quickly, and these small victories will allow you to build momentum and motivate you to keep going with the plan.
It also works because as you pay off each debt you are increasing what you pay towards the next debt, thus resulting in a faster balance clearance.
[Free Resource: Check your free credit report and score]What about the Interest?
Most of the other debt management methods available will suggest you pay the higher debts, or those with a higher interest rate first. In theory, the higher the debt, and the higher the interest, the bigger the debt will grow over a period of time. Therefore many believe the best way to clear debt effectively is to pay the debts with the highest interest first, giving you less time to compound the debt with interest charges.
Although this will save you money in interest, many people see it taking longer for the debts to go anywhere, thus getting disheartened and deviating from the system.
Getting the Most from the System
Something that could be worth considering when looking at the “Snowball method” is to think about the 0 percent balance transfer deals that may be available to you. These low interest deals allow you to move any existing debt onto a new credit card, but with a low or even 0 percent rate of interest for a promotional period.
If you were able to move some of your existing credit card debts onto interest free cards you would save a large amount of money on monthly charges, and this would allow you to carry out Dave Ramsey’s plan even more effectively. What you will need to look at is the length of time each low rate lasts for, as many people get caught out when these special deals end, and the card reverts to a much higher rate of interest.
Move The Highest Rates First
If you are going to incorporate a low rate strategy into the “Snowball method” what you should try to do is transfer the debts that are currently being charged at the highest rate of interest first. For example if you have one card that has an APR of 12 percent, and one with an APR of 18 percent you should move the debt being charged at 18 percent to the low interest card first.
Have a War Fund
Something that Dave Ramsey does suggest is that at the beginning of your debt clearance journey you should use any spare money to build yourself up a “war fund” which is kept separate from all other accounts. This money is kept only for use in an emergency.
This works well because one of the biggest problems people face when trying to clear multiple debts, is being hit by a situation that needs finance to be resolved. Often if something goes wrong with the car, or you have a problem with your home that needs fixing, with no money spare you may be forced to turn to your credit card which takes your debt clearance efforts into complete regression.
In conclusion, being in debt is no fun! The quicker you get out of trouble the quicker you can get back to enjoying your life!
These strategies can be amazingly powerful and effective when used together, and although it may seem like a long road ahead, the earlier you begin your journey, the quicker you will reach your destination.
This article was written by Timothy Ng from Sydney, Australia who writes about personal finance for Credit Card Finder . Have a read of Tim’s quick guide to comparing credit cards for some key points to consider next time you are looking to switch credit cards.
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