Posts Tagged ‘debt snowballing’

Debt Snowballing Explained

When financial author, David Ramsey presented the debt snowballing method as the most efficient way to obliterate debt, his idea was met with much contention from finance professionals. This did little to harm his reputation, particularly when a number of publications stepped up in defense of his methodology. Research began to emerge to validate the system. Basic debt management strategies can be split into two basic approaches. The practical approach uses number crunching to escape debt at the lowest possible interest rate. Here, debts with the highest interest rates are paid off first so that the principle repayment amount is minimized. The behavioral approach theorizes that debt management is a battle of the mind. Here, the smallest debts are paid off first, in essence allowing you to cross something palpable off a list. Minimum payments are maintained for all debts, but the focus and additional funds are fed into the smallest bill. Once that account has been settled, the funds that were funneled into the previous bill are dedicated to the next low ranking account. The motivation this induces is used to fuel future repayments.

Debt snowballing aims to gather momentum as it progresses by suggesting that the debtor works on small, manageable goals. The snowball effect comes into play when the paid accounts leave the debtor with more funds to apply to larger debts. Quick wins and small victories are potent motivators. Further incentive comes into play during the most challenging part of the repayment plan. Those seemingly impossible principle amounts can be paid off more speedily, giving the consumer the confidence and optimism required to combat these financial Goliaths.

Unmanageable debt imprisons people financially and emotionally. Those using Ramsey`s approach soon begin to see the cage bars vanish, giving a sense of freedom and power so necessary for those caught in the debt trap. The intense focus that comes from attacking each debt individually is remarkably empowering.

Debt snowballing is a simple method with a few peripheral guidelines. In even the most rational debt management tactics, an emergency fund should be saved in preparation for a focused repayment strategy. This prequel exists as a preventative measure that wards off financial emergencies that may tempt the debtor into taking out further debt. The snowball method demands that its users create solid restrictions on new debt.

The snowball effect appears to prioritize the battle of will and emotional impetus, but its numerical assets weigh up well against alternative methods that focus on reducing interest repayments. Repayment plans that cancel high interest bearing accounts first do give the debtor a slightly lower capital repayment over the plan`s life cycle. The numerical difference is, however, negligible and the debt snowball comes with the benefits of an improved sense of control.

The other addendum to Ramsey`s plan involves two accounts that bear the same amount of debt. In this situation, the account with the highest interest rate is paid off first. Another rider, which is too frequently ignored, entails reapplying every repayment amount attached to eliminated debts to the next account on the list. The final repayments will be massively increased as a result of these cumulative repayments. Without this aspect, there can be no true snowball effect and the advantages of the method will be purely emotional. All the practical profits delivered by the tactic will be eliminated entirely. Those who don`t use the numerical strategies of cumulative repayments are merely fooling themselves into a more sedate existence with minimal practical value.

For financial professionals, debt repayment tactics have always been a contentious issue. Rational approaches that are mathematically effective don`t appeal to the human nature of eliminating credit card debt. Ramsey claims that financial efforts are controlled less by the rational mind than personal behavioral habits. To help you compare the mathematical value of the rational and behavioral approaches to repayment plans, Simply Finance provides expert advice on all major strategies.

A Guide to Debt Snowballing

Many people nowadays are in debt and not sure how to pay off their bills. Various strategies have been developed by experts to help people pay off their debts in a systematic way. One of these strategies is known as the `debt-snowball method`. This method is ideal for those who owe money on several accounts.

People who implement this strategy start by paying off the smallest balance first, while only paying a minimum on the larger debts. As soon as the smallest debt has been paid off, the next step is to pay off the next largest balance owed. After this, it is a step-by-step process until the largest debt has been paid off completely.

The debt-snowball method is most often used to pay off revolving credit, such as credit cards. This strategy has recently gained a wider recognition because many wealth and financial experts are teaching it as the primary method of debt reduction. This method has always existed since many people naturally want to pay off small debts that are easier to take care of first.

The basic steps involved in snowballing debt:

1. Make a list of all debt owed in order from smallest to largest. This is what makes this system distinctive. The amounts listed are not based on how much interest is charged but on the total owed. That being said, if two debts are fairly close in amount, the one with the lower interest rate should be paid off first.

2. Make a commitment to pay the minimum amount on every item of debt.

3. Next, determine how much extra money you can afford to pay on the lowest debt. Pay the minimum owed on the smallest debt and add the extra amount you have determined. Do this until this particular debt is paid off.

4. Now add the minimum debt, plus any extra you can afford, from the old debt you just paid off to the minimum payment on the next smallest debt owed. This combined amount starts to really make a difference in the acceleration of payment. Repeat this step on the next debt once this one has been paid off. Continue until all debt is paid.

Some lenders, such as mortgage or car companies, apply the extra amounts to the next payment. For this method to work lenders have to be contacted and informed that the extra money is to go directly towards paying off the principal on the current cycle. Credit card companies usually apply the whole payment to current payment cycles. This method works because, by the time the final debt is reached, the extra cash paid toward the large debt grows quickly, similar to snowballs rolling down hills and collecting more snow.

The strategy works on a psychological level by giving ongoing positive feedback when individuals see increasing amounts of debt paid off. Mortgages are not generally included in this strategy but instead paid off as part of a person`s larger financial plans. People interested in financial products may be interested in checking out to compare rates, another way of reducing expenditure.