Debt Snowball Method: How It Works and When to Use It
The debt snowball method encourages people to pay off their smallest debts first. While continuing to pay the minimum on all other debts, people are instructed to pay as much of the excess payment as possible on the smallest debt. When the smallest debt is completely paid off, the same payment amount that was previously dedicated to the smallest debt is now used to pay off the next smallest debt.
The debt snowball method relies on an order of payment. While this method does not use a special financial offer or require refinancing, it does offer a means for people to tackle their debt in an orderly fashion. This method may help people achieve early milestones; however, it may result in more interest than targeting the highest-rate debt first because the smallest debts are not necessarily the most expensive.
Key takeaways
- Snowball order of payment: The smallest balance is the first debt to pay off, regardless of interest rate.
- Current accounts: Make each minimum payment and direct excess payments to one designated target.
- Continue payments: When a debt is paid off, use the payment amount to pay off the next debt instead of increasing spending.
- Consider tradeoffs: While a highest-interest-first payment strategy can lower the total interest paid, a debt snowball payment strategy is a good way to see progress early on.
- Essential expenses: A payment plan should not jeopardize the ability to cover essential expenses such as housing, utilities, food, insurance, or other necessary expenses.
How to build a debt snowball
- Creating a snowball without a template requires a list of your debts with a description of the terms associated with each. You’ll need to detail the current balance, interest rate, due dates, required payments, and any terms related to prepayments. Be sure to use recent copies of your statements; you should not estimate.
- Determine which debts require immediate attention. Take control of accounts that are delinquent and consider the implications of becoming delinquent on secured debts, taxes, child support, utilities, or federal student loans before you consider placing your debts in an order based on balance alone.
- Determine a comfortable payment amount that you can afford to make on a consistent basis. This payment must not rely on new borrowing.
- Organize your debts in order from smallest balance to largest balance. Once your debts are in order, use the tie-breaker based on the interest rate, fees, and any terms of promotional rates, or the risk related to the account.
- Make the required payments based on the terms of each debt. Send the extra payment to the debt with the smallest balance. Determine how your creditor or servicer will allocate excess payments; they may apply payments to a number of different amounts associated with your account.
- Once the debt you focused on is paid in full, move the payment you were making, including the extra amount, to the next account in the order. Repeat this process until the accounts you listed are paid off or you determine a different approach is needed.
When using shared drives or services, be sure to understand the privacy and security controls. A nickname-based personal payoff tracker works best; avoid using sensitive information.
A simple debt snowball example
Imagine a household with three separate debts that has an extra $100 available to contribute toward the target debt, on top of making the minimum payments. For the purpose of this exercise, we are going to pretend there is no interest and that the minimum payments do not change. Then the rolling mechanism is easier to see. It is not a complete estimate for the cost to pay off the debts.
| Order | Debt | Starting balance | Required payment | Payment while targeted |
|---|---|---|---|---|
| 1 | Credit card A | $600 | $30 | $130 |
| 2 | Medical payment plan B | $1,200 | $50 | $180 after A is paid |
| 3 | Personal loan C | $4,000 | $125 | $305 after A and B are paid |
Initially, let’s say Card A is paid the $30 minimum payment. The extra $100 goes toward this card as well. Once A is paid in full, that $130 moves to B. So B is paid $180. Once B is paid in full, that amount moves to C, making the total payment on C $305. The payment schedule will vary based on the payment amounts, the interest, payment allocation, and changes to the minimum payment. For installment accounts, the terms of the contract, as well as the personal loan agreement, will dictate how payments are allocated to principal, interest, and fees.
Debt snowball versus debt avalanche
The two strategies have the same objective of making the required payment on all debts and then using the extra money to make a payment on one debt at a time. The selection of the target is the only variable.
| Method | First target | Main advantage | Main tradeoff |
|---|---|---|---|
| Debt snowball | Smallest balance | This method may produce a completed payoff sooner, resulting in a reduced number of open balances | It may lead to more interest than a highest-rate-first approach |
| Debt avalanche | Highest interest rate | It will typically lead to the least amount paid in interest with the other factors held constant | The first payoff may take longer with the highest rate balance being larger |
The Consumer Financial Protection Bureau presents both the snowball and highest-interest-rate methods as debt-reduction approaches and notes their tradeoffs. While the snowball method may show progress sooner, the highest-interest-rate method can save more money in the long run. Your choice depends on whether it’s more important to mark quick wins or save money in the long term.
A hybrid method is even more flexible. Let’s say you pay down one small balance, and then move on to the highest-rate debt. This approach is flexible as long as the order is intentional, and required payments are not neglected.
Which debts need special handling?
Snowballs tend to work best with unsecured, consumer debts, like credit cards, medical payment plans, and other personal loans. The snowball order should not take priority over more urgent consequences. Falling behind on your mortgage or car payment may put your home or vehicle at risk. Falling behind on utility bills may result in a loss of service. Tax, child support, or student loan debts may have different rules for collection and repayment.
In the case that a debt is delinquent, reach out to the creditor or servicer before diverting additional funds. Again, the consequences of missing a loan payment are contract-specific, dependent on the account type, and the policies of the creditor, as well as the prevailing laws. Ask about an affordable repayment arrangement, and have the creditor document the arrangement.
Check for penalties for prepaying the loan, promotional rates that will expire, deferred-interest terms, and instructions for applying extra payments. The servicer may apply overpayments as a credit toward future payments. Review the next statement to confirm that the payment was correctly posted.
Should you borrow to consolidate a snowball?
A ‘snowball’ does not involve a new loan and does not require consolidation. A snowball changes the order of how payments are made toward the debt, while a consolidation loan changes the debt structure. A consolidation personal loan may only be beneficial if the terms of the loan improve the overall financial situation and the new consolidated payment is more manageable.
When looking at different loan options, consider the APR, the amount of the loan, the payment amount, the term, the total payment amount, the prepayment terms, and the risk involved. While a loan may offer a lower monthly payment, it may also increase the total payment amount of the loan. Exceeding the total balances being consolidated or even running the balances up again may result in more overall debt.
Affordability is not solved by payday loans or ‘bad credit’ products. High costs or short repayment periods can work against the plan and may leave people with more debt.
Common mistakes to avoid
- Ignoring interest rates: While it is important to look at how long it will take to make the last payment, interest plays an active role in how much a loan will cost. A smaller balance does not necessarily mean a lower interest cost.
- Using an unrealistic monthly amount: Planning for a snowball requires a review of irregular expenditures, or else the plan may force a later cutback or new borrowing.
- Skipping another required payment: Extra money sent to the target does not replace the required payments due on the other debts.
- Failing to verify payment allocation: Check the account records to make sure the extra payment reduced the intended balance and was not simply credited toward a future payment.
- Continuing to add new charges: New balances can offset progress unless the budget addresses the spending or income gap that caused them.
- Paying a debt-relief company before checking it: Warning signs include guarantees, pressure to stop communicating with creditors, and demands for upfront payment.
When to seek help
Expenditures that exceed incomes will require more than a self-directed snowball if accounts are in collection, necessary bills are at risk, legal steps have been taken, or the collection efforts are ongoing. Start by contacting creditors directly. The Federal Trade Commission advises consumers who are behind to explain the circumstances and ask the creditor about a payment plan they can manage.
A debt management plan for some unsecured debts is one of the options a reputable nonprofit credit counselor may review for you. Fees, the counselor’s qualifications, and licensing should be known before financial information is provided. Watch out for people who guarantee results, claim that a government plan will erase debt, or charge before providing debt-settlement services.
Frequently asked questions
Does the debt snowball work without extra money?
The ordering rule still applies, but progress will depend on the required payments and interest. Even without a fixed extra amount, redirecting a paid-off account’s former payment to the next balance can accelerate the payoff of subsequent debts. Completion date should not be assumed without the use of actual balances, rates, payment terms, and fees.
Should savings come before payments for extra debt?
There is no correct cash-buffer amount for all households. You need to consider the stability of your income, your insurance deductibles, and your expected future expenses, as well as access to resources and the cost and impact of each debt. Keeping some savings can reduce the chance that an unexpected expense creates a new balance.
Can the debt snowball help build credit?
Paying on time and keeping revolving balances low may affect information used in credit scoring; however, no matter what payment order you decide on, there is no guarantee nor a definitive amount of time that indicates a specific change or improvement to your credit score.
What happens if two debts have same balances?
Pick a method that establishes some order. Choosing the debt with the higher interest rate will usually reduce interest, or you could target a debt that has a serious contractual consequence or a deal that expires.
Bottom line
The snowball method has some merit. The priority for each of your payments is clear. You focus your extra payments on your smaller balances. The main cost is that you may end up paying more interest than with a highest-interest-first approach.
Have a cash buffer (emergency fund), review your current priorities, and see if your plan fits your current and expected future expenses. Contact creditors or seek the help of a reputable credit counseling service before you miss payments and incur higher costs.