Make the debt snowball work for you
Eliminating a large amount of debt may seem impossible, but it can work if you commit to a fixed total payment each month.
This post comes from Rob Berger at partner blog The Dough Roller.
In the past, we've talked about the debt snowball. Basically it's a simple way to accelerate the payoff of your debt. The key to using the debt snowball effectively is to either:
- Put extra money toward your debt above and beyond the minimum monthly payments.
- Or, if you don't, once your first debt is paid off, use the minimum payment that was required for that bill to accelerate the payment on one of your remaining debts.
With that in mind, here's a question a reader recently asked:
I don't see how you can pay off the smallest debts first when ALL the creditors are demanding payments RIGHT NOW. I feel overwhelmed and depressed. I'll probably be in debt for the rest of my life, and will die owing people money.
The comment raises two really important issues when you are trying to climb out of debt.
First, you should do everything in your power to make at least the minimum required monthly payments on your debt. If you don't, you'll get hit with late fees and interest. And your credit scores will eventually decline, perhaps precipitously.
As noted above, the idea of the debt snowball is to apply any extra cash you have to one of your debts. I believe it should generally be the debt with the highest interest rate. Others claim you should focus on the debt with the lowest balance. The bigger point is to just do it, whichever approach you choose. But you, of course, must make at least the minimum payment on all of your debts. (Post continues below video.)
And even if making the minimum payments on each debt is the best you can do, you can still take advantage of the debt snowball. Let's assume you have the following debt:
- Credit Card No. 1. $5,000 balance with a minimum payment of $100.
- Credit Card No. 2. $10,000 balance with a minimum payment of $200.
- Car loan. $15,000 balance with a minimum payment of $350.
Your total minimum payment for all three debts is $650 a month. With the debt snowball, you'll continue to pay at least $650 (more if you can) until all three debts are paid. That means, for example, that if you pay off Credit Card No. 1 first, you take the $100 minimum payment you had been making and apply it to one of the other debts.
It also means that you continue to pay $650 on your debts even if your minimum monthly payment goes down. This happens with credit cards as your balance declines. Generally, your minimum required payment on a credit card is calculated as a percentage of your outstanding balance (typically 2% to 4%). So as your balance declines, so does your minimum required payment. But with the debt snowball, you'd continue to pay $650 even as your required payments go down.
Second, does the debt snowball really work? The answer is yes. Based on this debt snowball calculator I recommend, the above debts could be paid off in about 68 months if you continued to pay $650 a month even as the required monthly payment declined.
But if you lower your payments as the required monthly payment declines, it will take as much as 21 years to pay off your debt (depending on which calculator you use, your results could vary). The point is, making just the minimum payments will result in a much longer time to pay off your debt.
More from The Dough Roller and MSN Money:
Copyright © 2013 Microsoft. All rights reserved.
Quotes are real-time for NASDAQ, NYSE and AMEX. See delay times for other exchanges.
Fundamental company data and historical chart data provided by Thomson Reuters (click for restrictions). Real-time quotes provided by BATS Exchange. Real-time index quotes and delayed quotes supplied by Interactive Data Real-Time Services. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by SIX Financial Information.