Debt snowball strategy: how does it work?

The debt snowball strategy is a method of paying off your debt by tackling your smallest balance first. You make the minimum payments on all of your debt, then any extra payments go toward your smallest balance. Once that’s paid off, you roll your payments into the next smallest debt.

This strategy can help borrowers manage their monthly debt payments more effectively, depending on their financial situation.

The debt snowball method is a debt repayment strategy that focuses on your lowest balances first and manages your payments to accelerate your path to debt freedom. It is especially suitable for borrowers who want a structured approach to debt repayment.

While the debt snowball method is not the only way to pay off debt faster, it’s a valuable approach if you’re disciplined and follow the steps. Here’s how it works and what to consider before using it.

What is the debt snowball method?

The debt snowball method requires you to pay the minimum amount due on all your debts, then allocate any extra amount you can afford to the account with the lowest balance.

Once you’ve paid off that balance, you’ll then take the amount you were paying toward it and add it to your minimum payment on the account with the next-lowest balance. You’ll keep doing this, creating a snowball effect with each debt you pay off, until you eliminate all of your debt.

This method is primarily used for paying down high-interest credit card debt, but it can also be used to pay down any non-mortgage debt, such as personal loans. The debt snowball method can also be applied to small loans, student loans, and private student loans.

Making timely loan repayments according to your loan agreement is crucial to avoid additional loan obligations.

How to pay off debt using the snowball method

Let’s say you have four loans and credit card balances you want to pay off. Here’s how you’ll approach your debt with the snowball method:

1. Set up automatic payments on all of your accounts for the minimum amount due. Make sure these payments are made on or before the payment date and due date to avoid penalties.
2. Review your budget to determine how much extra cash you can allocate toward your debt each month. This helps ensure you can make consistent monthly payments.
3. Add the extra amount to the payment on your smallest balance.
4. Once that debt is paid off, add the full amount you were putting toward it (the minimum payment plus extra) to your payment on the next-smallest balance.
5. After the second debt is paid off, take the full payment, including the minimum amount and extra amount from the first debt, and add it to your payment on the next-smallest balance.
6. Once the third debt is paid off, you’ll put the full amount you’ve been paying on your other debts toward your final balance until it’s paid off.

Using a current account for automatic payments can help streamline the repayment process.

Tip: If you’re paying down credit cards with the snowball approach, it’s a good idea to avoid using them for new purchases once you’ve paid off the balance.

Debt snowball example

Let’s say you have three loans and two credit cards with outstanding loan balances you’re trying to pay off. The table below illustrates the loan amount (the original sum borrowed or credited), the current loan balance for each account, and the annual percentage rate (APR), which reflects the total borrowing cost over the loan period:

The loan amount for each debt is determined by factors such as collateral value, credit history, and lender criteria, and it directly affects the total amount you will repay over the loan term, including both principal and interest payments.

The following table shows your total interest charges and amount of time to pay off the debt if you only make minimum payments each month (Tab 1), total interest charges and payoff timeline with the snowball method and no extra payments (Tab 2), and the impact having $150 extra per month to add to your debt snowball would make on your debts (Tab 3). The total amount in each scenario includes both the original principal and all interest payments made over the loan term or loan period.

Using the debt snowball method, you would first tackle the debt on credit card 2, as it has the lowest balance. When that’s paid off, you’d add the payment you were making on credit card 2 to the minimum fee for credit card 1, and so on until all your debts are paid off.

As you can see, even if you can’t manage to put any extra money toward your debt, using the snowball method will result in you paying off your debts more than five years sooner, and you’ll save more than €4,300 in interest payments.

But if you can manage to put even a little extra money toward your payments each month, you’ll become debt-free even faster and pay thousands less in interest.

Pros and cons of the debt snowball method

Before you proceed with the debt snowball strategy, it’s essential to consider both the advantages and disadvantages that come with it.

Pros

• Helps you save money: Even if you can’t put extra money toward your debt right now, the snowball approach can help you save hundreds or even thousands of dollars in interest.
• Accelerates your debt payoff: As you utilise the strategy’s snowball effect, you can cut years off of your debt repayment plan, freeing up that cash flow for other financial goals sooner.
• Can help you stay motivated: As with any debt repayment strategy, you’ll need to be disciplined and consistent with the debt snowball approach.

Cons

• May not maximise your interest savings: If you want to accelerate your debt repayment and save as much money on interest as possible, the debt avalanche method may be a better option—more on that in a minute.
• Can take a bit longer: If your largest balances also have your highest interest rates, it can take longer for you to pay off your debt, especially if the minimum payment on your most significant balances is relatively low.
• Need to stay focused: As you pay off balances, it can be tempting to rack up more debt, especially if you’ve had trouble with overspending in the past. Using the extra cash flow you gain from paying off each debt for other purposes may also be enticing. In other words, the debt snowball approach won’t magically change your habits, so you’ll need to stay focused on your objective. However, paying off smaller balances early on can help you stay motivated toward your goal.

Other Ways to Pay Off Debt

As you consider whether the debt snowball method is the right move for you, here are some other potential approaches you can take:

• Debt avalanche method: The debt avalanche method works similarly to the snowball approach, but instead of paying off the lowest balances first, it targets the accounts with the highest interest rates. The idea is that by eliminating the most expensive debts first, you’ll save more money on interest.
• Debt consolidation: Consolidating debt with a debt consolidation loan involves paying off multiple balances with a new loan or card. A consolidation loan can be used to pay off multiple existing loans, and eligibility depends on your credit scores and other factors, such as your financial obligations and credit history. Benefits may include a lower interest rate and a simpler repayment plan.
• Credit counselling: If you’re worried about falling behind on payments, you may consider consulting with a credit counsellor who can offer personalised advice. Suppose you have a lot of credit card debt. In that case, the counsellor may suggest a debt management plan, in which the counsellor negotiates a lower interest rate and monthly payment, giving you an affordable repayment plan. There are fees associated with debt management plans, and you may also be required to close your credit card accounts.
• Refinancing: is another option to manage debt. Refinancing involves replacing an existing loan with a new one to achieve better loan terms, such as lower interest rates, a longer or shorter loan period, or improved loan conditions. There are various types of refinancing, including rate and term refinancing, which allows you to change the interest rate or loan term, and cash-out refinancing, which enables you to access your home equity for other financial needs. You can refinance a home loan, mortgage loan, or private loan, each with its own requirements and benefits. The lender determines the desired loan amount, maximum loan amount, and maximum loan term based on the collateral and your financial obligations. 

Before you borrow money, always review all loan conditions and ensure you can meet your financial obligations.

Eliminating debt and improving your credit history won’t happen overnight. But if you’re disciplined and stick to your strategy, you could save years’ worth of time and interest charges, both of which you can spend working toward meaningful and exciting financial goals.