Debt snowball

What Is Debt Snowball?

The debt snowball is a debt repayment strategy within personal finance where individuals prioritize paying off their smallest debts first, regardless of the interest rate. Once the smallest debt is fully paid, the funds that were being applied to that debt are then added to the minimum payment of the next smallest debt, creating a "snowball" effect of increasing payment amounts on subsequent debts. This method focuses on psychological motivation by providing quick wins as smaller obligations are eliminated, which can encourage continued adherence to the repayment plan.²⁹, ³⁰

History and Origin

While the concept of systematically paying down debt has existed for a long time, the debt snowball method was popularized by American financial advisor Dave Ramsey. He advocated for this approach as a core component of his "Baby Steps" program, emphasizing that personal finance is "20 percent head knowledge and 80 percent behavior."²⁸ Ramsey argues that the psychological boost from rapidly eliminating smaller debts helps individuals stay motivated and committed to their overall debt-free journey, even if it might not be the mathematically optimal strategy in terms of interest paid.²⁷ Research from Northwestern University's Kellogg School of Management has also explored the behavioral efficacy of this method, suggesting that closing debt accounts, regardless of their dollar balances, can predict successful debt elimination.²⁵, ²⁶

Key Takeaways

• The debt snowball method prioritizes paying off debts from the smallest balance to the largest.
• It focuses on behavioral motivation, providing "quick wins" to encourage adherence to a debt repayment plan.
• After a debt is paid off, the freed-up funds are added to the payment of the next smallest debt.
• This strategy may lead to paying more interest over time compared to methods that prioritize high-interest debts.
• It is often applied to various forms of consumer debt, such as credit card debt and personal loans.

Interpreting the Debt Snowball

The debt snowball method is interpreted as a motivational tool designed to build momentum in a debt repayment journey. Rather than focusing on the interest rate, which would be the mathematically efficient approach, this method emphasizes the act of eliminating individual unsecured debt accounts. The core idea is that seeing debts disappear provides psychological gratification, making the daunting task of becoming debt-free more manageable and less overwhelming. Each paid-off debt reinforces positive financial behavior and frees up cash flow that can then be aggressively applied to the next obligation.²³, ²⁴ This systematic reduction in the number of outstanding minimum payment obligations can also reduce financial stress.²²

Hypothetical Example

Consider an individual, Sarah, with the following debts (excluding a mortgage):

• Credit Card A: $500 balance, 20% interest rate, $25 minimum payment
• Personal Loan B: $2,000 balance, 8% interest rate, $50 minimum payment
• Student Loan C: $8,000 balance, 6% interest rate, $100 minimum payment
• Auto Loan D: $12,000 balance, 5% interest rate, $200 minimum payment

Sarah commits an extra $150 per month towards debt repayment from her budgeting efforts.

1. List Debts: Sarah lists her debts from smallest to largest balance: Credit Card A ($500), Personal Loan B ($2,000), Student Loan C ($8,000), Auto Loan D ($12,000).
2. Minimum Payments + Extra: Sarah makes the minimum payments on Personal Loan B ($50), Student Loan C ($100), and Auto Loan D ($200). She then applies her minimum payment for Credit Card A ($25) plus the extra $150, totaling $175, to Credit Card A.
3. Credit Card A Paid Off: In less than three months, Credit Card A is paid off.
4. Snowball to Personal Loan B: Now, Sarah takes the $175 she was paying on Credit Card A and adds it to the $50 minimum payment for Personal Loan B. She now pays $225 per month on Personal Loan B, while continuing minimum payments on the other two.
5. Continue: This process repeats. Once Personal Loan B is paid off, the $225 (plus its minimum payment) is added to Student Loan C's payment, and so on, until all debts are cleared. This creates a powerful and motivating financial planning trajectory.

Practical Applications

The debt snowball method is primarily applied by individuals and households seeking to regain control over their finances and accelerate debt repayment. It is particularly effective for those who benefit from psychological reinforcement and visible progress. Many people utilize this strategy to tackle consumer debts, such as credit card debt, personal loans, and smaller student loans, which collectively can amount to significant financial burdens.²⁰, ²¹

For instance, in recent years, U.S. household debt has seen substantial increases across various categories, including credit card and auto loan balances.¹⁸, ¹⁹ Strategies like the debt snowball can provide a structured approach for individuals to manage and reduce these obligations. Financial counselors and organizations often introduce this method as part of broader debt management plans, recognizing its psychological benefits in helping clients stay committed.¹⁶, ¹⁷

Limitations and Criticisms

While highly motivational, the debt snowball method has notable limitations from a purely mathematical perspective. Its primary criticism is that by prioritizing smallest balances over debts with higher interest rates, it can lead to individuals paying more in total interest over the repayment period. The mathematically optimal strategy, known as the debt avalanche method, would instead focus on debts with the highest interest rates first to minimize the overall cost of borrowing.¹⁵

Some financial experts also point out that while the method provides quick psychological wins, closing credit card accounts after paying them off, which some adherents might do, could negatively impact an individual's credit score by reducing their available credit and potentially increasing their credit utilization ratio.¹⁴ However, proponents argue that the behavioral advantages, such as increased self-efficacy and sustained motivation, outweigh the potential for higher interest costs for many individuals struggling with debt.¹³ Recent research in behavioral economics continues to explore how such motivational factors influence debt repayment behaviors.¹¹, ¹²

Debt Snowball vs. Debt Avalanche

The debt snowball and debt avalanche are two popular debt repayment strategies, each with a distinct philosophy. The core difference lies in the order in which debts are prioritized for aggressive repayment.

The debt snowball method focuses on the number of debts being paid off, providing a powerful emotional boost as each account balance reaches zero.¹⁰ In contrast, the debt avalanche method focuses on the principal amount and the cost of debt, aiming to reduce the total amount of interest paid. Choosing between the two often depends on an individual's financial personality and what motivates them most effectively.⁸, ⁹ If quick progress is a primary motivator, the debt snowball might be more suitable. If maximizing financial efficiency is the goal, the debt avalanche is generally preferred.⁶, ⁷

FAQs

How do I start a debt snowball?

To start a debt snowball, list all your debts from the smallest balance to the largest, regardless of their interest rates. Make the minimum payment on all debts except the smallest one. Then, dedicate any extra money you have to paying off that smallest debt as quickly as possible.⁵

What kind of debts can be included in a debt snowball?

The debt snowball method is typically applied to consumer debts, such as credit card debt, medical bills, personal loans, and smaller student loans. Larger secured debts like a mortgage are usually excluded due to their size and lower interest rates.⁴

Will the debt snowball save me money?

While the debt snowball method is highly effective for motivation and adherence, it may not save you the most money in interest compared to the debt avalanche method, especially if your smallest debts do not have the highest interest rates. Its primary advantage is fostering sustained commitment to the financial planning process.

What happens after I pay off a debt with the snowball method?

Once a debt is paid off, you take the money you were dedicating to that debt (its minimum payment plus any extra funds) and add it to the minimum payment of the next smallest debt on your list. This increases the payment amount on the next debt, accelerating its payoff and creating a "snowball" of payments. This continues until all debts are eliminated, ultimately contributing to wealth building.², ³

Can I use the debt snowball if I don't have an emergency fund?

It is generally recommended to have a small emergency fund in place before aggressively tackling debt with methods like the debt snowball. This provides a buffer against unexpected expenses, preventing you from incurring new debt if an emergency arises.¹