Getting Rid of Debt With the Snowball Method
A huge amount of personal debt can cause a person a lot of headaches and stress. And while every year millions of Americans make debt reduction one of their New Year resolutions, like other resolutions this one usually goes unfulfilled. Perhaps what’s needed is a solid plan that’s easy to follow? Here is one such plan…
Save or Pay Down Debt?
The first step towards freedom from debt is to – save some money. $1,000 would be a good start, and the sole purpose of this is to establish an emergency fund. Why save money first instead of paying down the debt immediately? Well, it may seem a little counter-intuitive, but the reasoning is that a person without an emergency fund will have nothing to fall on in case something happens, and will then be forced to use credit cards again if the unexpected happens. This would obviously throw your debt-elimination efforts off track, and therefore a safety cushion is necessary. Eventually (after the debts have been eliminated), the emergency fund should grow to about three-months-worth of your monthly expenses.
Elimination by Snowball
After the initial emergency fund has been established, it’s time to attack the debt with gusto. The common advice is to start paying down those debts with the highest interest rate. However, many financial experts recommend starting with the debts with lower balances instead. The reason? The “snowball effect.” Let me explain…
First, list all your debts, their minimum payments and balances. Then decide what’s the highest monthly payment you can afford for all of them. Pay minimum payment on all debts except for the one with the lowest balance – on that one make the highest payment you can. Once you pay it completely off, add that payment to the next lowest debt, and so on. By doing this the monthly payment for the “target” debt will snowball as you go along, while your total monthly payments remain the same.
Let’s use an example... Suppose you have 4 credit card accounts with minimum monthly payment of $100 each. And let’s say you can afford $500 in total payments. Pay minimum payment ($100) a month on each of the three cards with the higher balances, and the remaining $200 a month throw on the card with the lowest balance. Once that balance is completely paid off, add those $200 to the minimum payment ($100) of the next-lowest balance. Just like a snowball, your payment has increased – to $300 a month! Repeat until all balances are zero.
The advantage of this approach is obvious. You’ll start raking up victories sooner. And each time you pay off a balance, you increase the payment on the next debt and speed up its elimination! Of course, it takes time to completely erase all debt – after all you did not incur it overnight, so you can’t get rid of it overnight either. But this plan does work and in the effort will be worth it.
Just like in sports, one must play good offense and defense in order to win. Both are equally important. Attacking the debt is the offense. Not incurring new debts is the defense. To help you play better defense, start by using credit cards less. Or better yet, don’t use them at all. Leave credit cards at home. Cut them up. Freeze them. Start carrying cash. Many financial advisors suggest withdrawing a set amount from your bank account, and using cash to pay everyday expenses. It’s been noted that when a person pays with the good old greenbacks, he or she spends less then when paying with plastic. When you really have to pay with a card (for example, when shopping online), use debit card. Also, don’t take out new loans needlessly. Yes, a new car would be nice, but wouldn’t financial freedom be nicer? The most basic rule of personal finance says that a person should spend less then he or she earns. Trying to stick with that rule may sometimes be hard, but it’s the only way towards debt-free life.
Personal Finance Blog
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