Debt-snowball method
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The debt-snowball method of debt repayment is a form of debt management that is most often applied to repaying revolving credit — such as credit cards. This method has gained more recognition recently due to the fact that it is the primary debt-reduction method taught by Dave Ramsey.
Snowballing is also recommended by many other finacial websites such as [The Motley Fool], [Money Saving Expert.com] and [What's The Cost] (Where a calculator can show the savings you'll make by snowballing in the correct order).
Method
The basic steps in the debt snowball are:
- List all debts in ascending order from smallest balance to largest.
- Commit to pay the minimum payment on every debt.
- Determine how much extra can be applied towards the smallest debt.
- Pay the minimum payment plus the extra amount towards that smallest debt until it is paid off.
- Then, add the old minimum payment from the first debt to the extra amount, and apply the new sum to the second smallest debt.
- Repeat until all debts are paid in full.
All retirement contributions are to be halted during the debt snowball, thus freeing up more money to pay down the debt snowball. Many dispute this practice, citing the cost of compounding interest to be greater than the gains of paying off debt. Some comprimise by reducing retirement contributions to only what a company will match with an employee. Ramsey teaches that this halting of retirement contributions should last no more than two years.
A first home mortgage is not included in the debt snowball, as it is handled in "Baby Step 6" (Pay off the house early). Any debt which is equal to or greater than half of one's annual take-home pay is also pushed off the debt snowball and onto Baby Step 6.
Variations
Some financial advisors suggest a variation of this strategy in which the debts are listed in descending order according to the interest rate that is charged. The idea is to reduce the debts that are growing the fastest in order to minimize the total amount of interest paid. Others recommend paying the debts that cause the most worry or stress.Ultimately, the best choice depends on the situation and outlook of the debtor. Those who are unsure of their ability to stick with the plan may want to pay the smallest debt first, because the thrill of eliminating an entire balance sooner may encourage them to continue. If an interest-free loan from a sibling or parent has gone unpaid for so long that it threatens to destroy a relationship, it would be a logical first choice for repayment.
See also
External links
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