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.

VIDEO

Loading the player...

BREAKING DOWN '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.

 

RELATED TERMS
  1. Debt

    An amount of money borrowed by one party from another. Many corporations/individuals ...
  2. Credit Card

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

    How Long Bankruptcy Will Affect You

    How long will the sad chapter of bankruptcy impact the rest of your life?
  7. Credit & Loans

    Guidelines for FHA Reverse Mortgages

    FHA guidelines protect borrowers from major mistakes, prevent lenders from taking advantage of borrowers and encourage lenders to offer reverse mortgages.
  8. Investing

    What’s Holding Back the U.S. Consumer

    Even as job growth has surged and gasoline prices have plunged, U.S. consumers are proving slow to respond and repair their overextended balance sheets.
  9. Credit & Loans

    What's a Nonperforming Loan?

    A nonperforming loan is any borrowed sum where the borrower has failed to pay scheduled payments for at least 90 days.
  10. Savings

    How Volatile Exchange Rates Affect Your Vacation

    Those ever-changing fluctuations can make a difference in anything from your hotel room to an ATM transaction.
RELATED FAQS
  1. How can I take a loan from my 401(k)?

    The majority of employers offer eligible employees the opportunity to save for retirement in a qualified plan through paycheck ... Read Full Answer >>
  2. What is the difference between "closed end credit" and a "line of credit?"

    Depending on the need, an individual or business may take out a form of credit that is either open- or closed-ended. While ... Read Full Answer >>
  3. What is the best way to start to rebuild your credit after a bankruptcy?

    Bankruptcies can be devastating to your credit score. Even worse, a bankruptcy will be listed on your credit report for between ... Read Full Answer >>
  4. What is the difference between a possessory and a non-possessory lien?

  5. Why is more interest paid over the life of a loan when it is capitalized?

    More interest is paid over the life of a loan when that interest is capitalized because the capitalized interest is added ... Read Full Answer >>
  6. What are the differences between Chapter 7 and Chapter 13 bankruptcy?

    In the United States, the most common kinds of personal bankruptcy filings are under Chapter 7 or Chapter 13 proceedings. ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Financial Crisis

    A situation in which the value of financial institutions or assets drops rapidly. A financial crisis is often associated ...
  2. Election Period

    The period of time during which an investor who owns an extendable or retractable bond must indicate to the issuer whether ...
  3. Shanghai Stock Exchange

    The largest stock exchange in mainland China, the Shanghai Stock Exchange is a nonprofit organization run by the China Securities ...
  4. Dead Cat Bounce

    A temporary recovery from a prolonged decline or bear market, followed by the continuation of the downtrend. A dead cat bounce ...
  5. Bear Market

    A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment ...
  6. Alligator Spread

    An unprofitable spread that occurs as a result of large commissions charged on the transaction, regardless of favorable market ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!