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Weather The Debt Conditions

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Debt snowballing is a term used to describe a particular method of dealing with debt, which in some ways goes against ‘traditional’ thinking. It’s commonly advised to deal with the most expensive debt first in terms of interest rates and charges, which is a natural and effective approach to paying down debt.

But one issue that isn’t taken into account when repaying debt in this way is the psychology that can sometimes influence a successful outcome.

What is the ‘traditional’ way to pay off debt?

In theory, repaying the most expensive debt first – i.e. the one with the highest rate of interest – offers the best chance of becoming debt-free in the shortest time. Sometimes known as the debt ‘avalanche’ method, you prioritise debts according to the rate of interest rather than the amount outstanding.

This minimises the interest paid over the long-term, but there are significant drawbacks to the avalanche method in terms of psychology. However logical the system, if you have a relatively large debt with a high interest rate it can feel frustrating and de-motivating when the balance doesn’t reduce quickly and your other debts remain in the background.

So how does debt snowballing work, and could it be a great alternative?

Here’s how to debt snowball

  • Make a list of all your debts – the one with the smallest balance at the top.
  • Pay off the minimum amount on all your credit cards and other debts, apart from the one with the smallest balance.
  • Pay as much as you can off this debt and repeat each month until you’ve paid it off in full.
  • Cross it off your list of debts and use the money released towards the next debt.
  • Continue in the same way down your list (the second smallest next), making the minimum payment on all other borrowing.
  • If you’re able to earn more money, putting it towards the debt you’re currently repaying increases the snowball effect and reduces your overall level of borrowing.
  • When the debt you’re focusing on has been paid off, cross it off your list – rinse and repeat until you’re debt-free.

Human psychology when paying off debt

Debt snowballing is a system that applies a little human psychology to paying down debt and acknowledges that we all lack motivation at times. The method only works if you have sufficient funds to make the minimum payments on all your debts however, so if you don’t, you would need to look at alternatives.

The sense of accomplishment when you can cross a debt off your list is invaluable in encouraging you to carry on and could in fact be one of the main reasons for the success of debt snowballing.

It can be overwhelming to pay off one debt for a long time and still have other debts that aren’t reducing, but by getting rid of several in quick succession you establish momentum and can change your overall financial situation.

The extra money that’s freed up when one debt is repaid should be used to pay the next one, so you’re overpaying more and more as you go through your list – hence the ‘snowball’ reference.

It seems to be a simple method, but exactly why could debt snowballing offer a better outcome than other debt repayment methods?

Advantages of debt snowballing

  • It offers vital motivation.
  • It’s a simple and straightforward system that’s easy to maintain.
  • You’re forced to focus on one debt at a time, and as long as you keep up the minimum payments on other debts you can forget about them for a while.
  • It helps you manage your money for the long term and introduces good money habits.

The debt avalanche method is very effective as long as you have the motivation to continue, but paying off the smallest debt first, and then the next smallest, offers a psychological boost that can encourage you to keep going.

Are there any downsides to debt snowballing?

The main downside of debt snowballing is the extra interest you pay on your debts when compared with the debt avalanche method, and when considered only from a mathematical point of view it clearly isn’t the most obvious option.

Repaying debt is a little like dieting, however – small wins offer the motivation that many people need to continue and succeed. One important issue is to make sure you dedicate any money released when a debt is repaid to paying off the next one. Without this, the ‘snowball’ effect of increasing amounts being available to tackle your next debt doesn’t materialise, and the system will stall.

When all your debts have been paid back, it’s advisable to use your newly increased residual income to start an emergency fund if you don’t already have one, and then to save or invest for your future.

Debt snowballing isn’t just a good way to become debt-free – it can be the foundation for a ‘wealth snowball’ if you save or invest the money that was once swallowed up by credit card and other debt repayments.

By Ann Haldon

 

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