What exactly is the debt snowball, and why is it such an important part of your plan?
The debt snowball is Baby Step 2 of my plan for getting out of debt and gaining control of your finances. Specifically, it’s the part of the plan where you sit down with your budget and look at all the money you owe. Then, list your debts from smallest to largest - except for your home - and pay them off in that order.
I know, there are all sorts of arguments about paying off the ones with the highest interest rates first. But this is psychology class, not math. Personal finance is 80% behavior and 20% knowledge. Besides, if you were so great at math you wouldn’t have debt, would you? Pay off your debts from smallest to largest, unless there’s a huge emergency, such as you’re facing foreclosure, or the IRS is banging on your door.
The reason we pay off debts from smallest to largest is to build confidence and enthusiasm by notching quick wins. If you go on a diet and lose weight in the first week, you’ll probably stay on that diet. If you go on a diet and gain weight, or go weeks with no visible progress, chances are you’ll quit. When you start the debt snowball, and in the first few days pay off a couple of debts, it lights a fire underneath you, and you start to believe you really can do it.
After you list the debts from smallest to largest, pay the minimum payment to stay current on all the debts except the smallest. Every dollar you can squeeze out of your budget goes toward the smallest debt until it is paid. Once the smallest one is paid, the payment from that debt - plus any extra “found” money - is added to the next smallest debt. Then, when debt number two is paid off, you take the money that you used to pay on number one and number two, and you pay it on number three. When three is paid, you attack number four and so on. A lot of folks get to the bottom of the list and find they can pay well over $1,000 a month on a student loan or a car. At that point, it won’t take long to bust out and be debt-free except for your home.
The main elements that make the debt snowball so powerful are budgeting, getting current before you start the debt snowball, the smallest-to-largest pay-off, sacrifice, discipline and focused intensity. If you think the debt snowball is just another trick, or something you might kind of try, it won’t work. You’ve got to go all-in to win!
Dave Ramsey is CEO of Ramsey Solutions. He has authored seven best-selling books, including "The Total Money Makeover." "The Dave Ramsey Show" is heard by more than 14 million listeners each week on 600 radio stations and multiple digital platforms. Follow Dave on the web at daveramsey.com and on Twitter at @DaveRamsey.