The Snowball Effect on Debt

The Snowball Effect on Debt
Eileen St. Pierre, The Everyday Financial Planner

In last week’s post Which Bill Should I Pay First?, we discussed debt reduction strategies. A very effective strategy is called the Snowball Effect that starts with paying off the lowest balances first.

Here’s an example:

Debt

Balance Interest

Rate

 Monthly

Payment

Credit Card 1 $200 18% $50
Credit Card 2 $500 19% $25
Car Loan $20,000 10% $370.52

You decide to focus on paying off credit card 1 first, then move to credit card 2, and finally knock off your car loan.

  • You have a 6-year car loan so you have 72 monthly payments.
  • Your total monthly debt payments are $445.52 – this is how much you are budgeting towards debt repayment.

Here’s the payoff:

Using an accelerated debt payoff calculator like those at Calculators.org or PowerPay.org, we get the following payoff schedule after selecting to pay off the lowest balance first:  

Payment Credit Card 1 Credit Card 2 Car Loan
1 $50 $25 $370.52
2 $50 $25 $370.52
3 $50 $25 $370.52
4 $50 $25 $370.52
5 $7.84 $67.16 $370.52
6   $75 $370.52
7   $75 $370.52
11   $13.03 $432.44
12     $445.52
60     $50.75

During the 5th month, the first credit card bill is paid off. You then can devote the freed up $42.16 to credit card 2. In month 6, you now have $75 to put towards credit card 2. Just make sure you don’t start using credit card 1 again! Keep making your car loan payment.

During month 11, you will have credit card 2 paid off. You now have extra money to put towards your car loan. From month 12 on, you can now put your entire $445.52 budget towards your car loan. Doing this, you will have your car loan paid off during month 60.

Giant_snowball_OxfordHere are the results of this strategy:

  • You will save $1,154 in interest.
  • You will pay off your car one year early.

Visit my Debt Management page for more information.