Some of you may be asking what a snowball has to do with debt reduction. Think of it this way, have you ever seen a snowball rolling down a hill and as it goes it starts increasing in size, getting bigger and bigger? Creating a snowball debt reduction plan works the same way as a snowball rolling down a hill. The farther down the hill it goes the greater it becomes, similarly with your debt payments as you pay off one debt and roll the extra money into another your debt reduction starts taking effect as you pay it down faster and faster with larger payments. There are some things you should know to make your snowball debt reduction plan effective.
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 payment amount and the interest rate.
Analyze Your Debts
The second thing you need to do is analyze your list. Review which debts are closest to being paid off, and also order the debts by the highest interest rate first. Here’s why, every dollar you pay against the highest interest rate balance is interest saved. For example if you pay $100 on the balance of a credit card charging 18% you save $18 a year. If you take the same $100 and pay on your student loan that only charges 3% you only save $3 over a year. You can save a lot in interest by simply paying any additional payments on the highest interest balances first.
Create a Budget
Once you have your list, and have ordered the debts in order of highest interest 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 item 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. 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. For example if your payment on a credit card was $100 and you were paying that extra $25, you were paying $125 each month. When that debt is paid off you simple apply that extra $125 to the next debt. If you had another high interest rate credit card with a $100 payment now you would pay the $100 and the $125 for a total of $225. Continuing the process you may have a car payment next on the list with a payment of $300. Adding an additional $225 to the payment each month pays it down faster. By the time you get to your last debt on the list you may be paying an extra $1,000 or so. For most people this will be on their home. Can you imagine how fast you would pay off your house if you had no other debts and paid an extra $1,000 each month? It’s worth the effort.
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.