Make a List
First thing you need to do is make a list of all of your debts. Include everything from student loans and car payments to credit cards and your mortgage payment. It is critical in your planning that you include all of your debts so you can carefully analyze which payments will be most effective. There are three important things you should include in this list, the balance of the debt, the minimum payment amount and the interest rate.
Analyze Your Debts
The second thing you need to do is analyze your list. Review all of you debts and arrange them in order from smallest to largest. This is where you start with the snowball debt reduction plan. There is another way to order them which is sometimes referred to an avalanche debt reduction plan. Using this method you would order them by the highest interest debts first, but for snowball plan let’s stick with the lowest balance first.
Create a Budget
Once you have your list, and have ordered the debts in order of highest balance first you are almost ready to create your own snowball debt reduction plan. Before you decide how much to pay you also need to prepare a simple budget. Here is where you identify how much extra you can afford to pay against that first loan on the list. This is not mandatory, but if you can start by adding even $25 a month to that first debt you’ll get your snowball rolling faster.
So make a list of all you monthly bills, look for ways to save on expenses and sacrifice a little to come up with those extra dollars. If you need a few ideas on how to pinch some extra pennies you can check it out here. Or, if you are like me you would rather just figure out how to make an extra income on the side. Either way if you can add more to the payments other than the minimum, it will make a world of difference in the end.
Start Your Snowball Debt Reduction
Now its time to get started, every month pay that first bill on the list and anything extra you have add to the balance. The snowball debt reduction plan starts working as soon as the first debt gets paid off. Once you have those extra funds from paying off the first debt you immediately roll them into the next.
Here’s a simple example. Let’s say you have the following debts:
- $300 Department Store Card – Payment $25
- $600 Medical Bill – Payment $50
- $3,500 Credit Card – Payment $95
- $12,000 Car Loan – Payment $240
- $16,000 Student Loan – Payment $185
These are just a few examples, it will be different for everyone. Let’s say after you did all of your budgeting you were able to come up with and extra $200 to put towards your debts. When you make your payments you add that extra $200 payment to the lowest balance on the list, so instead of paying $25 on the Department Store Card you pay $225. It’s paid off on the second month and now you take it and roll it onto the next bill.
Now you are paying $50 plus the $225 from the other bill on the Medical payment. In less than 3 months you have it paid off freeing up another $50. After the medical bill is paid you have the $25 plus the $50, plus the $200 ($275 total) to roll into the next bill. This is starting to add up quickly and you are only about 6 months into the snowball plan.
When you start paying the credit card you’ll be paying the regular $95 plus the $275 you freed up from the others, so now instead of paying the minimum of $95 you are paying $370. You can probably see where this is going. At this point the credit card balance is probably somewhere around $3,100 because you’ve been paying the payments for the last 6 or 7 months and now you are going to start with payments of $370. It will probably take about 10 months to finish it off. At this point it’s only been a year and a half or so and you would be down to the last 2 debts.
Next you’ll hit the car loan doing the same thing. Take the normal payment of $240 and add the $370 for a total payment of $610. Now you can really see the snowball debt reduction really start to roll. In less than 2 years that car loan will be paid off and you will be on to the next one. At this point until you are finished you are making payments of $795 a month on your student loans. Finally, light at the end of the tunnel!
Stay Focused
What Happens Now?Like with every other debt reduction plan, the snowball debt reduction plan takes one key ingredient, discipline. Every time you retire a debt you will be tempted to use the additional cash flow for things you want. That’s the key, they are just ‘wants’ not things you need. If you stay focused and work hard you can speed up the payment process and become debt free.
Hey you’re debt free! Congratulations! Now what happens? You’ve created some great habits and should be pretty accustomed to living on the budget without that extra $795. If you haven’t already fully funded your emergency fund, now is the time to finish that up. If you’ve checked that off of the list the next thing to look at is your retirement fund. Are you on track? Do you know what your needs are or will be? The point is don’t just start spending that extra $795 every month just because you can. Do some planning and make your money work for you instead of you working for it for a change.