Before we go into creating a debt reduction plan, let’s make sure you’re up to speed on certain debt terms.

Interest Rate: The interest rate is the percent of the amount you borrow that you pay to the lender in addition to the principal.

Annual Percentage Rate: This is the interest rate charged per year for purchases you make with a credit card, and may include other fees.

Minimum Payment: Loans and credit cards have a minimum amount you must pay each month on the balance, though you certainly can pay more.

Bankruptcy: If you’re unable to pay off your debts, filing bankruptcy may be a last-ditch solution to consider. 

Essentially, it reduces or eliminates your debts. Know that it will negatively impact your credit for many years. That’s why it’s worth it to come up with a plan for the ultimate debt payoff strategy.

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What Is the Debt Snowball?

Just like an actual snowball, the debt snowball method starts out small. You first tackle the smallest debt balances you have. Once those are paid off, you apply what you were paying on those to the next smallest debts. You continue to pay at least the minimum due on all your debts.

However, by focusing your attention on one debt at a time, you then free up more money to make larger payments on other debts until it’s all gone. Your snowball of debt repayment, so to speak, grows over time.

Benefits of the Snowball Method

The snowball method is one of the fastest ways to pay off debt. And over time, this method will help you have fewer payments as you pay off credit cards and loans and put more money to the remaining debt.

Drawbacks of the Snowball Method

The smallest debts you have may not be the ones with the highest interest. So while you’re paying off the little loans, the debts with higher interest continue to accumulate interest, which adds to your debt.

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Debt Snowball vs. Debt Avalanche

If you have larger loans with higher interest, the debt snowball method may not be your best option. You might also explore another popular way to pay off debt: debt payoff strategy, the debt avalanche method.

With the debt avalanche method, you start paying down the loans and credit cards with the highest interest first. By doing so, you reduce the amount of debt you have at those higher interest rates, which slows down the amount of interest that accumulates over time.

Just like with the snowball, you pay off one debt and then put the money you were paying on that debt toward the loan or card with the next highest interest rate until it’s all paid off.

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How Is Debt Snowball Payoff Calculated?

To use the debt snowball payoff method, you’ll need to gather information about all the debt you have. Let’s use the following example:

Personal loan 1 balance: $3,000

• 12% interest
• Minimum payment: $100 per month

Credit card A balance: $2,000

• 17% interest
• Minimum payment: $25 per month

Credit card B balance: $1,000

• 22% interest
• Minimum payment: $30 per month

Personal loan 2 balance: $750

• 8% interest
• Minimum payment: $20 per month

Even without a snowball debt payoff calculator, you can reorder these debts so that you focus on the one with the lowest balance first:

• Personal loan 2: $750
• Credit card B: $1,000
• Credit card A: $2,000
• Personal loan 1: $3,000

Now that you’ve ordered your debts from least to greatest, you can see how, once you pay off the $750 loan, that money can go toward the credit card with the $1,000 balance. Once that’s paid off, you put all that money toward paying off the $2,000 credit card balance, and then finally, to pay off the $3,000 loan.

(Learn more: Personal Loan Calculator)

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Debt Snowball Payoff Examples

Let’s look at what the monthly payments for these reordered debts would look like, if you were able to set aside $400 a month toward paying them off.

As the chart shows, what might have taken you years to pay off can be paid off in under two years with the debt snowball method.

One way to keep your finances on track while you’re paying off debt is to create a budget. A money tracker app can help you come up with a spending and saving plan that works for you.

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The Takeaway

If you’re trying to pay off outstanding debt, you have options. The debt snowball method has been proven effective for many people. If nothing else, it’s a way for you to focus your attention on whittling down debt and minimizing how much you pay in interest.

This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.

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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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