How Does The Debt Snowball Strategy Work?

The debt snowball strategy is a loan balance reduction method that works by paying off the smallest loan first. This strategy is one of the popular debt management methods that mainly aims to offer a stress relief solution to the borrower.

The snowball strategy focuses on the borrower’s psychological happiness. It gives the borrower a victory feeling by paying off the smallest debts first.

Debt snowballing is a popular loan consolidation alternative particularly applicable for a person with multiple loan balances that create stress.

The snowball strategy is only applicable for debt relief seekers while the method only focuses on paying off small balances without considering the borrowing cost comparison.

Key Takeaways

• The snowball method focuses on paying off the smallest loan first
• This method is good for psychological stress relief
• The snowball method is not a cost-effective debt management strategy as it ignores the net debt cost.
• People with more financial stress and less debt management knowledge can be the appropriate user of the snowball method.

What is the debt snowball method?

The debt snowball method refers to paying off the smallest debt loan first. Once the borrower has paid his smallest loan, he can continue the ladder by paying another loan that is the smallest among the all available.

Per the debt snowball method, a borrower must rank all available loan outstandings.

After that, the borrower targets the tiniest loan liability and starts additional savings to settle off that debt.

Once done, the borrower again targets the small amount of debt and increases the savings to pay off the loans.

That’s how the snowballs start.

Here’s an example:

Let’s assume you have the following debts:

• Credit Card A: $500 balance, $25 minimum payment
• Credit Card B: $1,200 balance, $50 minimum payment
• Personal Loan: $5,000 balance, $150 minimum payment
• Car Loan: $10,000 balance, $200 minimum payment

You decide to use the debt snowball strategy. Here’s how you would proceed:

During months 1 to 5, you will target paying off ‘Credit Card A’, which has a $500 balance.

• Credit Card A: Pay $200 per month ($25 minimum payment + $175 extra).
• Credit Card B: Pay $50 per month (minimum payment).
• Personal Loan: Pay $150 per month (minimum payment).
• Car Loan: Pay $200 per month (minimum payment).

After 5 months, your Credit Card ‘A’ bance would be nill…

Now it’s time to target another liability (smallest among all available debts).

During the months 6 to 17, pay $225 per month ($50 minimum payment + $175 extra from Credit Card A) to pay off Credit Card ‘B’.

As a consequence, Credit Card B will be paid off in 12 months (a total of 17 months).

You can then target the personal loan from the savings and reserve money that you used to pay for the credit Card A & B.

During the month 18-37, pay $375 per month ($150 minimum payment + $225 extra from Credit Cards A and B).

Similarly,

You can start paying off the car loan from months 38-57 (after you paid the personal loan in full on month 37).

That is how the debt snowball strategy works.

Scenario Illustration

This table aims to illustrate how does the snowball mechanis mwork.

What are the benefits of the snowball method?

In simple terms, the debt snowball method offers a simple way of debt repayment that offers a psychological boost and encourages discipline in debt handling.

The core benefits are:

• Paying off smaller debts quickly provides a sense of accomplishment and motivation to continue.
• Easy to understand and implement without complex calculations.
• As each debt is eliminated, more money is freed up to tackle the next debt, creating a snowball effect.
• Encourages discipline and good financial habits, as individuals see tangible progress.
• Immediate success can help build confidence and reduce financial stress.
• Helps individuals stay focused on paying down debt rather than being overwhelmed by the total amount owed.
• Can be adjusted to fit individual financial situations and goals.

Learn more about the debt snowball and avalanche methods here.

What are the negative sides of the debt snowball strategy?

The main negative sides of the debt snowball strategy are as follows:

• This may result in paying more interest over time compared to strategies that prioritize high-interest debts.
• From a purely financial perspective, the debt avalanche method (focusing on high-interest debts first) is more cost-effective.
• Larger debts may take longer to address, potentially prolonging the financial burden.
• Some individuals may become complacent after paying off smaller debts and lose momentum before addressing larger ones.
• Paying off smaller debts first may not significantly improve credit scores if larger, high-interest debts remain.
• Focusing solely on the balance size can lead to higher overall interest payments if high-interest debts are not prioritized.
• Success depends on the ability to consistently make extra payments, which may be challenging for some.
• It does not consider identifying the bad debts that create financial strain.

How effective is the debt snowball method?

The debt snowball method is effective for those borrower who suffers from psychological stress while with multiple debts.

The snowball method is only effective when borrowers need to see immediate progress to stay motivated with their loan payments. For instance, a person with multiple small credit card debts who feels overwhelmed. Paying off one card quickly can boost their confidence and determination to tackle the next.

The effectiveness of the snowball method is also significant in people who struggle with maintaining financial discipline. For example, someone who has never successfully followed a budget or debt repayment plan may benefit from the structured, easy-to-follow approach of the debt snowball method.

Similarly, this strategy helps people with several small debts rather than a few large ones. By washing out the smaller liabilities, it gets easier to focus on the larger debts and also helps to make extra savings.

Overall, the debt snowball method targets financial stress reduction to address psychological motivation and financial discipline to save more. Especially, during the significant financial stress, debt relief providers often apply this method to reduce the loans.

Harvard Business Review (2016) found that individuals using the debt snowball method were more likely to eliminate their debt due to the motivational benefits of quick wins. We saw similar evidence in a study published by Northwestern University in 2012, which showed that the debt snowball method’s emphasis on small victories is critical for maintaining motivation and long-term commitment.

How does the debt snowball method affect credit score?

The debt snowball method can have both positive and negative effects on your credit score, depending on how it is implemented and individual financial circumstances. Primarily, it reduces credit utilization and slightly boosts the credit score by making timely payments.

However, a short-term credit score fluctuation can be seen due to closing loan accounts that reduce the overall credit limit.

As you pay off debts, your credit utilization ratio (the amount of credit you’re using compared to your total credit limit) decreases, which can positively impact your credit score. Similarly, making consistent, on-time payments improves your payment history, which is a significant factor in your credit score.

More importantly, paying off smaller debts first reduces the number of open accounts with outstanding balances, potentially boosting your score.

But, if you pay off and close a credit card with a $1,000 limit, your total available credit decreases, which could negatively impact your credit utilization if other balances remain the same.

You need to keep in mind that paying off a small balance and closing the account might cause a temporary dip in your credit score before the positive effects of reduced overall debt take hold.

What alternatives do you have for the debt snowball method?

Debt avalanche, consolidation, balance transfer, and getting a paid debt management plan are the four alternatives to the debt snowball method. Each with its advantages and disadvantages.

Here’s a table for a quicker understanding

Method	Focus	Best For	Interest Savings	Psychological Impact
Debt Snowball	Smallest balance first	Those needing quick wins and motivation	Higher overall interest paid	High (due to quick wins)
Debt Avalanche	Highest interest rate first	Those wanting to minimize interest	Lower overall interest paid	Moderate (slower initial progress)
Debt Consolidation	Combining debts	Those wanting simplified payments and potentially lower rates	Depends on new loan terms	Moderate (due to simplification)
Balance Transfer	0% APR period	Those with high-interest credit card debt and good credit	High if balance paid within intro period	Moderate to High (depends on discipline)
Debt Management Plan	Structured repayment plan	Those needing professional help and lower interest rates	Moderate (depends on negotiated terms)	Moderate (due to structured support)

The debt avalanche method focuses on paying off the debt with the highest interest rate first while making minimum payments on the other debts. Once the highest-interest debt is paid off, move to the next highest-interest debt.

The debt avalanche method is mathematically optimal as it minimizes the amount paid in interest and creates extra room for additional savings.

However, The debt avalanche method cannot offer the borrower a psychological boost by focusing on the shortest way of winning.

Debt consolidation works by combining all the prevailing loans into a single one. This can be done through a personal loan, home equity loan, or a debt consolidation loan.

The consolidation simply simplifies monthly payments by combining multiple debts into one, potentially a lower interest rate and flexible term. However, debt consolidation is another loan that requires you to have a good credit score.

Transferring debt balance from one to another can also be an alternative to the debt snowball method. For example, you can transfer debt balances from Credit Card A and Credit Card B to a new credit card with a 0% APR for 18 months. Technically it sounds like a consolidation but only applies to credit cards.

Balance transfer provides a temporary break from interest, allowing more of the payment to go towards the principal. It may offer you psychological peace by reducing the number of loans but, there would not be any reduction in monthly payments. By transferring the balances, you can merge your multiple credit cards into one but, it does not mean creating additional financial space for making more savings and being financially solvent than before.

Lastly, you may work with a credit counseling agency to create a structured repayment plan. Normally, the agencies negotiate with the lenders to lower interest rates and waive fees. However, credit counseling affects the credit score significantly as it represents that the borrower is not in a suitable position to make debt payments.

Bottom line

The debt snowball method is just a strategy to help you pay off your loans by prioritizing the smaller outstanding first. This method motivates a borrower to lower the number of loans gradually and brings financial disciplines to handle the larger ones.

No matter what is your debt management methods, you will only need to prioritize your debts and make additional savings with a financial plan.