Debt Snowball

AAA

DEFINITION of 'Debt Snowball'

A method of debt repayment in which the debtor lists each of his/her debts from smallest to largest (not including the mortgage), then devotes extra money each month to paying off the smallest debt first while making only minimum monthly payments on all of the other debts.

Once the smallest debt is paid off, the debtor starts putting extra money each month toward paying off the second-smallest debt while continuing to make only minimum monthly payments on all other debts. The debtor continues this process, paying off each debt from smallest to largest, until all of the debts are paid in full. The debt snowball method is advocated by Dave Ramsey, the host of a popular call-in personal finance advice radio show and bestselling author of several books and programs on getting out of debt.

INVESTOPEDIA EXPLAINS 'Debt Snowball'

Each debt’s interest rate is not a factor in selecting the order in which the debts are repaid using the debt snowball method. While repaying debts starting with the highest-interest debt and ending with the lowest-interest debt, a method called the “debt avalanche,” will cost debtors less in interest over the long run if they stick with the program, the debt snowball method can be more effective in reality because of the psychological benefits of generating a win each time a debt is paid in full.

Paying off five debts can seem more manageable if the list is quickly whittled down to a single debt by paying off the smaller debts first. The debtor might get frustrated and quit the repayment plan if the highest-interest debt were one of the largest debts and had to be repaid at the beginning of the plan.

Here’s an example of how a debt snowball works. Let's say an individual can afford to put $1,000 every month toward retiring his three sources of debt: $2,000 worth of credit card debt (with a minimum monthly payment of $50), $5,000 worth of auto loan debt (with a minimum monthly payment of $300), and a $30,000 student loan (with a minimum monthly payment of $400). Using the snowball method of debt repayment, he will spend a total of $750 on paying each debt's minimum monthly payment. He will put the remaining $250 toward the credit card debt, because it is the smallest of the three debts.

Once the credit card debt has been completely paid off, the extra payment will go toward retiring the second-largest debt, the auto loan. At that point, the debtor will be spending $700 a month on minimum monthly payments and will have $300 extra to put toward the auto loan each month. Once the auto loan is paid off, all $1,000 will go toward the student loan until it, too, is paid in full and the individual is debt free. Like a snowball, each paid-off debt frees more cash to go toward eliminating the remaining ones.

 

VIDEO

Loading the player...
RELATED TERMS
  1. Credit Card

    A card issued by a financial company giving the holder an option ...
  2. Debt

    An amount of money borrowed by one party from another. Many corporations/individuals ...
  3. Interest Rate

    The amount charged, expressed as a percentage of principal, by ...
  4. Waterfall Payment

    A type of payment scheme in which higher-tiered creditors receive ...
  5. Budget

    An estimation of the revenue and expenses over a specified future ...
  6. Line Of Credit - LOC

    An arrangement between a financial institution, usually a bank, ...
RELATED FAQS
  1. How have low interest rates affected lease rates in the automotive sector?

    Low interest rates have contributed substantially to increased lease rates in the automotive sector. In recent years, the ... Read Full Answer >>
  2. How often is interest compounded?

    Interest can be compounded on any given frequency schedule. Common interest compounding time frames are daily, monthly, semi-annually ... Read Full Answer >>
  3. What is the difference between a savings & loan company and a bank?

    Savings and loan (S&L) companies provide many of the same services to customers as banks, including deposits, loans, ... Read Full Answer >>
  4. What are the pros and cons of getting installment credit to pay off your revolving ...

    Whether it is to finance big-ticket items, cover unplanned emergency expenses or provide a monetary cushion when cash flow ... Read Full Answer >>
  5. What is the difference between a collateralized debt obligation (CDO) and an asset ...

    An asset-backed security (ABS) is a security created by pooling non-mortgage assets that is then resold to investors. A collateralized ... Read Full Answer >>
  6. What is the most important "C" in the Five Cs of Credit?

    Financial institutions attempt to mitigate the risk of lending to unworthy borrowers by performing a credit analysis on individuals ... Read Full Answer >>
Related Articles
  1. Credit & Loans

    Credit, Debit And Charge: Sizing Up The Cards In Your Wallet

    Not all plastic is equal! Learn the difference between the three kinds, and how each can affect your finances.
  2. Credit & Loans

    How To Reduce Holiday Debt

    Holiday expenses can drown you in debt. Find out how to avoid this festive spending hangover.
  3. Credit & Loans

    Take Control Of Your Credit Cards

    The plastic in your wallet doesn't have to hurt your finances. Learn how to manage it responsibly.
  4. Retirement

    Understanding Credit Card Interest

    Paying these rates can impact your disposable income and your investment returns.
  5. Credit & Loans

    Digging Out Of Personal Debt

    Find out why good intentions can put consumers in an even bigger hole than before.
  6. Credit & Loans

    The Pros & Cons Of Personal Loans vs. Credit Cards

    One is not like the other. We help you decide where to borrow money from.
  7. Credit & Loans

    How Is Cashback Profitable For Credit Card Companies?

    Cashback rewards are not as beneficial to the consumer as they might initially seem.
  8. Credit & Loans

    Consolidating Debt: What If You Have Bad Credit?

    Getting a debt consolidation loan is more difficult when you have bad credit. But it could still help put you on the road to improving your credit score.
  9. Savings

    Why Do Credit Cards Expire?

    Credit cards expire for more reasons than you could imagine – including, so you don't forget you have the card.
  10. Credit & Loans

    Meet The Company Behind Your FICO Score

    There are other credit scores that evaluate lending risk, but FICO is still the choice of most U.S. lenders.

You May Also Like

Hot Definitions
  1. Fixed-Income Arbitrage

    An investment strategy that attempts to profit from arbitrage opportunities in interest rate securities. When using a fixed-income ...
  2. Venture-Capital-Backed IPO

    The selling to the public of shares in a company that has previously been funded primarily by private investors. The alternative ...
  3. Merger Arbitrage

    A hedge fund strategy in which the stocks of two merging companies are simultaneously bought and sold to create a riskless ...
  4. Market Failure

    An economic term that encompasses a situation where, in any given market, the quantity of a product demanded by consumers ...
  5. Unsystematic Risk

    Company or industry specific risk that is inherent in each investment. The amount of unsystematic risk can be reduced through ...
  6. Security Market Line - SML

    A line that graphs the systematic, or market, risk versus return of the whole market at a certain time and shows all risky ...
Trading Center