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. Waterfall Payment

    A type of payment scheme in which higher-tiered creditors receive ...
  4. Interest Rate

    The amount charged, expressed as a percentage of principal, by ...
  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. 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 >>
  2. 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 >>
  3. What is the difference between a possessory and a non-possessory lien?

  4. 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 >>
  5. 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 >>
  6. What is the difference between a lien and an encumbrance?

    A lien represents a monetary claim levied against property to secure payment of an obligation of the property owner, while ... 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

    Credit Card Review: Blue Cash Everyday Amex

    Read about the Blue Cash Everyday Amex card, and learn how it saves cardholders money on groceries, gas and other household purchases throughout the year.
  7. Credit & Loans

    Credit Card Review: Chase Freedom

    Learn about the Chase Freedom card and how it earns 1% cash back on every purchase and up to 5% on purchases in quarterly categories.
  8. Credit & Loans

    Credit Card Review: Citi Double Cash

    Learn about the Citi Double Cash credit card and its simple cash back program that pays a combined 2% rate on every card purchase.
  9. Credit & Loans

    Credit Card Review: Amex EveryDay

    Learn the benefits of the Amex EveryDay card, such as its introductory offer and rewards perks, and discover the types of consumers for whom it is best suited.
  10. Credit & Loans

    Credit Card Review: Capital One Venture Rewards

    Learn how the Capital One Venture Rewards card helps you earn unlimited rewards miles to pay for all types of travel expenses, such as airfare and hotel costs.

You May Also Like

Hot Definitions
  1. Topless Meeting

    A meeting in which participants are not allowed to use laptops. A topless meeting organizer can also ban the use of smartphones, ...
  2. Hedging Transaction

    A type of transaction that limits investment risk with the use of derivatives, such as options and futures contracts. Hedging ...
  3. Bogey

    A buzzword that refers to a benchmark used to evaluate a fund's performance. The benchmark is an index that reflects the ...
  4. Xetra

    An all-electronic trading system based in Frankfurt, Germany. Launched in 1997 and operated by the Deutsche Börse, the Xetra ...
  5. Nuncupative Will

    A verbal will that must have two witnesses and can only deal with the distribution of personal property. A nuncupative will ...
  6. OsMA

    An abbreviation for Oscillator - Moving Average. OsMA is used in technical analysis to represent the variance between an ...
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!