Debt snowball method

The debt snowball method is a debt-reduction strategy, whereby one who owes on more than one account
pays off the accounts starting with the smallest balances first, while paying the minimum payment on larger
debts. Once the smallest debt is paid off, one proceeds to the next larger debt, and so forth, proceeding to
the largest ones last.[1] This method is sometimes contrasted with the debt stacking method, also called the
debt avalanche method, where one pays off accounts on the highest interest rate first.[2][3]

The debt-snowball method is most often applied to repaying revolving credit – such as credit cards. Under
the method, extra cash is dedicated to paying debts with the smallest amount owed.[4]

Methodology
The basic steps in the debt snowball method are as follows:

1. List all debts in ascending order from smallest balance to largest. This is the method's most
distinctive feature, in that the order is determined by amount owed, not the rate of interest
charged. However, if two debts are very close in amount owed, then the debt with the higher
interest rate would be moved above in the list.
2. Commit to pay the minimum payment on every debt.
3. Determine how much extra can be applied towards the smallest debt.
4. Pay the minimum payment plus the extra amount towards that smallest debt until it is paid
off. Note that some lenders (mortgage lenders, car companies) will apply extra amounts
towards the next payment; in order for the method to work the lenders need to be contacted
and told that extra payments are to go directly toward principal reduction. Credit cards
usually apply the whole payment during the current cycle.
5. Once a debt is paid in full, add the old minimum payment (plus any extra amount available)
from the first debt to the minimum payment on the second smallest debt, and apply the new
sum to repaying the second smallest debt.
6. Repeat until all debts are paid in full.

In theory, by the time the final debts are reached, the extra amount paid toward the larger debts will grow
quickly, similar to a snowball rolling downhill gathering more snow, hence the name.

The theory appeals to human psychology: by paying the smaller debts first, the individual, couple, or family
sees fewer bills as more individual debts are paid off, thus giving ongoing positive feedback on their
progress towards eliminating their debt.

Example
An example of the debt-snowball method in action is shown below. In a real payoff scenario the different
interest rates on debts will affect payoff times and might make the debt-snowball method less efficient than
other plans. However, for the sake of illustrating the method, the example ignores accruing interest.

A person has the following amounts of debt and additional funds available to pay debt (the debt is listed
with the smallest balance first, as recommended by the method):
 Credit Card A – $250 balance – $25/month minimum
Credit Card B – $500 balance – $26/month minimum
Car payment – $2500 balance – $150/month minimum
Loan – $5000 balance – $200/month minimum
The person has an additional $100/month which can be devoted to repayment of debt.

First two months – under the debt-snowball method, payments would be made to the creditors as follows:

Credit Card A – $125 ($25/month minimum + $100 additional available)

Third month balance (presuming the person has not added to the balances, which would defeat the purpose
of debt reduction) – Credit Card A would have been paid in full, and the remaining balances as follows:

Credit Card B – $448

Third month payments – the person would then take the $125 previously used to pay off Credit Card A and
apply it as additional payment to the Credit Card B balance, which would make payments for the next three
months as follows:

Credit Card B – $151 ($26/month minimum + $125 additional available)

Three more months (six total) – Credit Card B would be paid in full (the final payment would be $146),
and the remaining balances would be as follows:

Car Payment – $1750

Then the person would take the $151 previously used to pay off Credit Cards A & B and apply it as
additional payment to the car loan balance, which would make payments as follows:

Car Payment – $301 ($150/month minimum + $151 additional available)

It would take six months to pay the car loan (the final payment being $240), whereupon the person would
then make payments of $501/month toward the loan (which would have a $2800 balance) for six months
(with the last payment at $234). Thus in 17 months the person has repaid four loans, with two of them
being paid in five months and three within one year.

Effectiveness
In situations where one debt has both a higher interest rate and higher balance than another debt, the debt-
snowball method prioritizes the smaller debt even though paying the larger, higher-interest debt would be
more cost-effective. Several writers and researchers have considered this contradiction between the method
and a strictly mathematical approach. In a 2012 study by Northwestern’s Kellogg School of Management,
researchers found that "consumers who tackle small balances first are likelier to eliminate their overall debt"
than trying to pay off high interest rate balances first.[5] A 2016 study in Harvard Business Review came to
a similar conclusion:

We tested a variety of hypotheses and ultimately determined that it is not the size of the
repayment or how little is left on a card after a payment that has the biggest impact on people’s
perception of progress; rather it’s what portion of the balance they succeed in paying off. Thus
focusing on paying down the account with the smallest balance tends to have the most
powerful effect on people’s sense of progress – and therefore their motivation to continue
paying down their debts.[6]

Author and radio host Dave Ramsey, a proponent of the debt-snowball method, concedes that an analysis
of math and interest leans toward paying the highest interest debt first. However, based on his experience,
Ramsey states that personal finance is "20 percent head knowledge and 80 percent behavior" and he argues
that people trying to reduce debt need "quick wins" (i.e., paying off the smallest debt) in order to remain
motivated toward debt reduction.[7]

Research by Moty Amar and colleagues agreed that debtors are inclined to pay small debts first, which they
attributed to "debt account aversion", the desire to reduce the number of outstanding debts regardless of
balance or interest expense.[8] However, they also found that when debtors are restricted from fully paying
debts and are shown the interest that will accrue as a result of their choice, they make the mathematically
optimal decision.[8]

See also
Personal finance
Alternative financial service

References
1. https://www.daveramsey.com/blog/get-out-of-debt-with-the-debt-snowball-plan – Get Out of
Debt With a Debt Snowball
2. "Debt Snowball Vs. Debt Stacking" (http://budgeting.about.com/od/Debt/a/Debt-Snowball-Vs
-Debt-Stacking.htm). About.com.
3. "How Does Debt Stacking Work?" (http://classroom.synonym.com/debt-stacking-work-1264
4.html). Synonym.com.
4. "How a `debt snowball` plan works" (http://www.allaboutmoney.com/debt-advice/debt-snowb
all-0-2646.htm) Archived (https://web.archive.org/web/20140222055100/http://www.allabout
money.com/debt-advice/debt-snowball-0-2646.htm) 2014-02-22 at the Wayback Machine, All
About Money
5. "The 'snowball approach' to debt - Kellogg School of Management" (http://www.kellogg.north
western.edu/news_articles/2012/snowball-approach.aspx).
6. "Research: The Best Strategy for Paying Off Credit Card Debt" (https://hbr.org/2016/12/resea
rch-the-best-strategy-for-paying-off-credit-card-debt). Harvard Business Review. Retrieved
2017-03-17.
7. Dave Ramsey (2009). The Total Money Makeover: A Proven Plan for Financial Fitness.
Thomas Nelson Inc, ISBN 978-1595550781
 8. Amar, Moty; Ariely, Dan; Ayal, Shahar; Cryder, Cynthia E.; Rick, Scott I. (2011). "Winning the
Battle but Losing the War: The Psychology of Debt Management". Journal of Marketing
Research. 48: S38–S50. doi:10.1509/jmkr.48.SPL.S38 (https://doi.org/10.1509%2Fjmkr.48.S
PL.S38). S2CID 55616109 (https://api.semanticscholar.org/CorpusID:55616109).
SSRN 1760528 (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1760528).

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