I’m a sometimes listener to Dave Ramsey’s radio show (it’s not consistently on the air in my area) and I’ve recently read Ramsey’s The Total Money Makeover. In both, Ramsey advocates a concept that he calls the “debt snowball.” Here’s how it works.
First, make a list of all of the debts you have, with the debt with the lowest balance at the top of the list. When I first made a list like this, it actually hurt. I had several credit card bills, an automotive loan, and multiple student loans. No home loan (yet), thank god, or else I might have had a coronary right then and there.
Then, allocate as much of your monthly budget as you can to debt elimination. Right now, we’re budgeting about 35% of our income towards killing the debt. We did this by trimming away a lot of wasteful spending and converting that straight into debt reduction payments.
Next, make minimum payments on all of the debts except for the one at the top of the list. I literally made a list of each minimum payment and kept a running total of them to see how much I had left in my “debt” budget. The debt budget slowly got smaller, but the bills were getting paid and I knew that the end would be good.
As for that top debt, pay the absolute maximum amount you can on that debt until it’s gone. This meant that a pesky small credit card bill went first. It only took a month of this focus to eliminate the first one – and it felt really good.
Why is this called a debt snowball? Once you’ve paid off a debt, there’s a new debt at the top of the list. But suddenly there’s also one fewer debt that you’re just making minimum payments on. So the amount of money you can apply each month to paying off this new “top” debt is a little bigger. Each time you pay off a debt, the amount you can apply to remaining debts is a little bigger, much like a snowball rolling down the hill. When all of your debts are gone, you’ll be living a lifestyle much cheaper than what you can afford, so you can take that snowball and start investing it and saving it.
In my own life, I’ve been using a variation on the snowball system. I call it the “scared straight” snowball. Basically, it works the same as the debt snowball, except that I just make minimum payments on all of my debts and put the remainder of my “debt elimination” budget into a high-yield savings account. Once the amount in that account exceeds the amount remaining on my top debt by more than 30%, I write a check to pay off all of that remaining debt, leaving me with fewer minimum payments each month and more to “snowball” into my savings account.
Why do I do this? It’s less cost effective than the real snowball method, that’s for sure, so I’m losing some money doing it this way. But I gain something valuable (to me) in return, and that’s security. If you follow the traditional debt snowball route, it’s assumed that you have a small amount in an emergency fund in case things go bad. Well, I often feel like my emergency fund is far too small. I imagine my job disappearing or my child getting hurt or a vehicle dying or some similar disaster – or a combination of disasters. As a child, I watched such incidents happen and nearly tear my family apart – and I swore I would never allow myself to be in that tenuous of a situation.
So I do the debt snowball my own way, with a bit less risk. Call me chicken if you wish, but this method gives me a sense of security that I don’t get from the ordinary debt snowball.