FOOL'S EYE VIEW
Dealing with Debt: Snowballing Works

By Jane Mack (TMFJane)
September 4, 2001

Have you ever heard of "snowballing"? Lots of people haven't and yet it's one of the easiest and simplest methods to use when trying to get shot of debts. It's also extremely effective.

I haven't a clue where the word comes from in relation to clearing debt but it's an apt description because that's exactly what happens. Just as snowballs get bigger and bigger as they roll down the hill, so do debts get crushed and annihilated at a faster rate the more you practise it.

The idea of snowballing is to single out one credit card as your target and throw all the money you can at it whilst making minimum payments on all the other debts. Once you've paid off your first target debt, you then use all that freed-up money to tackle the next one on your list. Have a look at this example for three credit card debts:

Debt   Amount Owed    APR   Minimum Payment 

CC1      £1,000       22%         £50
CC2      £5,000       12%        £150
CC3     £10,000        6%        £300   

You owe a total of £16,000 and your minimum payments each month are £500. It's quite a scary number, and it's obviously going to take a long time to pay these cards off if you only make the stated minimum payments. Three years and one month actually – and that's only if you keep paying the same amount each month. You'll be looking at many more years if you reduce your minimum payments whenever the credit card companies tell you that you can.

But let's say you've managed to pare down your expenditure so that you've got a spare £200 available each month on top of the £500 minimum payments for all of the debts. Where do you start?

Well, logically, it makes sense to focus on the most expensive debt first – the £1,000 with an APR of 22%. (It also has the added bonus of being the smallest debt so you'll get a result pretty quickly, which should prove motivating).

So, let's pay the minimum of £50 + the spare £200 towards this debt -- a total of £250 – whilst continuing to make the minimum payments on the others. Note that, as you gradually pay off this first debt, you'll be told that your minimum payment has been cut – but don't reduce it! Keep paying it off at the same rate. You'll have cleared CC1 after five months.

Obviously, you'll then have a spare £250 a month to throw at the next debt. If you add that £250 to the £150 you're paying for CC2, you'll have a total of £400 to chuck at this second debt. Because you've also been making minimum payments whilst paying off CC1, you'll have cleared CC2 17 months from now.

Eventually, you'll have £400 available to add to the £300 you're paying for CC3 – a total of £700 a month. Wow! You'll be shot of that debt in no time at all! Debt-free two years and one month after you started – and you'll have saved yourself a bundle in interest at the same time.

Can you see how the "snowball" has got bigger and bigger? If you'd just made the same minimum payments listed in the table, it would have taken you three years and one month to clear your debts. But using this method, you'll be "clean" a whole year sooner – and £700 a month richer!

Obviously, to snowball effectively, you have to have more money available than what's necessary to merely meet the minimum payments. You need to look at your expenditure and see where you can make cutbacks so that you've got some extra money to start the snowball rolling.

Look at your income and outgoings as a whole first of all. Have a look at our Get out of Debt Centre where you can fill in our Statement of Affairs calculator to see exactly what your financial situation is. You can find out how to get a better deal on your mortgage, your utilities and your credit cards and loans – free up some money for your snowball fund. You'll realize, for example, that our first credit card debt – the £1,000 at the astronomical interest rate of 22% - could be transferred to a card with a much lower rate, which will make your snowballing efforts even more effective.

Finally, as a special treat, I'm going to point you in the direction of a spreadsheet which was devised by one of our American Fools for people who are in debt. Look at the example and then fill in the "Blank" section. It's obviously in dollars but you can ignore that bit and just substitute £ signs in your head. It enables you to enter each of your debts, the relevant interest rates, the amount of money you've got available to pay off the debts etc and it tells you how quickly you can pay them off depending on whether you do this, that or the other. It's very popular on our US boards and I'm not surprised really – it's great fun playing with it.

More: The Fool's Get Out Of Debt Centre