Debt Snowball Into Savings Or Pay Off Debt?

The idea of debt snowballing is a popular one: it pushes you to get rid of your debts and get on a financially stable playing field, plus it encourages you to behave in a frugal fashion because you’re setting aside such a large, steady block of money each month to eliminate those debts.

What’s a debt snowball? From an earlier post:

A debt snowball (or similar arrangement) is simply a debt repayment plan that specifies the order in which you should pay off your debts. Typically, there is some logic in the order – in Dave Ramsey’s original debt snowball, the debts were ordered from smallest to largest, for example. You then add up the minimum payments for this snowball, add an additional amount to that total, and then treat that dollar amount as your “debt bill” for the month.

From this “debt bill,” you make the minimum payments on all of your debts, then use the remainder to make extra payment on whichever debt is on top of the list. When that one is paid off, you don’t reduce the total of your “debt bill” – instead, you just have a larger remainder to tackle whatever debt is now on top of the list. Eventually, you’ll be using the whole “debt bill” amount to tackle that final debt – and it will melt away quite quickly.

The concept of the “debt snowball” was first popularized by the radio host Dave Ramsey, and his plan is probably best described in his excellent book The Total Money Makeover.

But, as I mentioned before, there’s a big problem with the whole debt snowballing idea and that’s security.

Debt snowballing requires you to roll a large amount of your income each month into debt repayment, and if you get through the entire plan without any problems, it works like a charm. But life rarely works that way. People lose their jobs. People switch careers. People have children unexpectedly. People fall in love and get married. People get hit by trucks. Things happen, in other words, and if you’ve tied up all of your money in getting out of debt and left almost nothing liquid for yourself, those things can really derail your dreams.

So here’s my alternate plan, one I’ve been using for the last two years to handle larger debts. Instead of paying extra debt payments each month, I instead roll a certain amount each month into my emergency fund savings account. When I have enough in that emergency fund account to pay off my next debt and leave enough in the emergency fund so that I’m comfortable (six months’ worth of living expenses), I pull that cash out and pay off the debt. I’m actually pretty close to doing this right now to pay off one of our outstanding debts.

I tried other plans for a while because this plan does have flaws, but the benefits of doing it this way kept bringing me back. Here’s how both sides of the coin look.

A debt snowball savings account offers more security Instead of having your cash wrapped up in extra debt payments, it’s easily available in cash form from your savings account if you need it for an emergency. Lose your job? It’ll be much easier to survive with cash in the account than with lower debts. The same goes for almost every kind of emergency you can think of – having the cash is much better than having lower debt.

A debt snowball savings account offers more life possibilities Similarly, with the money available to you, you have much more freedom when it comes to making choices about your life. Want to switch careers or have a child? You’re not lashed to the debt snowball routine, giving you room to make these choices without sweating it.

A debt snowball savings account slows your net worth improvement Financially, this method isn’t nearly as effective as actually paying down the debts. The 3% you might earn in a savings account is far lower than the 7% or more you’d get from eliminating debts. That difference adds up to a lot of money over time.

A debt snowball savings account makes it easier to spend If you have a big wad of cash just sitting there, it’s easier to talk yourself into spending a little bit more. The debt snowball savings account requires you to have plenty of diligence and discipline; if you don’t, it won’t be very effective.

For me, the net balance is a positive for the savings account. It enabled me to switch careers and have a second child without sweating every dime. Since I have some degree of discipline (I’m far from perfect, but we are spending far less than we earn), I’m not tempted to tap into the money. The only part that itches at me is the loss in net worth growth, but I view it as almost being a form of insurance, and that slower growth is the fee I’m paying for this insurance against whatever may come.

The balance on the whole may be different for you. Give it some thought and come to your own conclusions based on your own situation. For example, if you’re single and are more concerned about financial independence than anything else, a normal debt snowball may be the highly preferred choice.

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