Sunday, February 5, 2012

Snowballing 101

A few friends have asked me to explain what snowballing debt is, and why it is a good thing. I am happy to oblige! Snowballing is perhaps the major thing I've learned from all this Dave Ramsey business, besides a successful budget, which I'll explain next time!

So, let's say Jan and Jim Minivan have 3 major monthly debts. They have a credit card debt of \$100, a student loan for \$200 and a car payment for \$300 (not to mention the mortgage on their house). Let's say the minimum payment on each of those is 10%. So they are already spending \$60 per month and the finance charges keep acruing. And perhaps Jan keeps shopping at Nordy's. And Jim wants a new TV. You get the pictures.

But what if they decide to snowball their debt? They can do it over a year, and while they may have to cut their spending by a bit, they won't be eating rice and beans every night, unless they choose to! Let's say they are able to pay an extra \$20 per month to pay down their debt.

Snowballing means paying the most you can on your smallest debt while still paying the minimum on your other debts. When that debt is paid off, you roll that amount on to the next debt, and so on. Here's what it looks like:

Month 1: CC: \$10 min + \$20 snowball = \$30 (\$70 left)
Month 2: CC: \$10 min + \$20 snowball = \$30 (\$40 left)
Month 3: CC: \$10 min + \$20 snowball = \$30 (\$10 left)
Month 4: CC \$10 min = \$0 left!  Credit Card Paid Off! Take the extra \$20 and celebrate, or put it towards the next debt...
Month 5: SL: \$20 min + \$10 CC + \$20 snowball = \$50 (\$150 left)
Month 6: SL: \$20 min + \$10 CC + \$20 snowball = \$50 (\$100 left)
Month 7: SL: \$20 min + \$10 CC + \$20 snowball = \$50 (\$ 50 left)
Month 8: SL: \$20 min + \$10 CC + \$20 snowball = \$50   \$0 left! Student Load Paid Off!!!
Month 9: Car: \$30 min + \$10 CC + \$20 SL + \$20 snowball = \$80 (\$220 left)
Month 10:Car: \$30 min + \$10 CC + \$20 SL + \$20 snowball = \$80 (\$140 left)
Month 11:Car: \$30 min + \$10 CC + \$20 SL + \$20 snowball = \$80 (\$60 left)
Month 12:Car: \$30 min + \$10 CC + \$20 SL = \$60 \$0 left!  Car Paid Off! Take the extra \$20 and celebrate, or put it towards savings...

See how this works? If the Minivans had continued to pay the minimum and continued to charge on the cards, they might never have paid them off. With a little tightening of the budget and a strict no more credit cards philosophy, the Minivans have successfully eliminated their debt. Now they can save for the future and not simply pay for the past.

Will it be hard? Yes. Will Jan get grumpy when she can't purchase a new pair of jeans on a whim? Sure. But she'll love being able to, eventually, perhaps upgrade their old minivan for a snazzy new Mini Cooper. Who knows what they will decide to save for?

Will Joe grumble and fuss with the controls to get better color on his old 30" TV? Yes. But in a few years, with a healthy retirement fund and savings in the bank, he will be able to upgrade his entire entertainment system, if he chooses. Who knows if he will even want to by then?

I love this plan. I am so grateful to 52 Bites for introducing it to me! Love it! You can buy the \$5 e-book by following this link, or clicking on the picture on the right. Or you can simply research snowballing debt - I'm sure you'll find a lot of information. 52 Bites just has that, and more!

Next up - the zero-based budget!

1 comment:

1. Another good one.
Where were you ,when I was young and foolish