Imagine rolling a small snowball down a hill — you start with your smallest debt, and as you pay it off, the money you free up adds to the next one, making the snowball (and your payments) grow bigger and faster. Over time, that momentum helps you crush your larger debts, just like a snowball gaining size and speed downhill.
Key takeaways:
- The debt snowball method is a coined term that utilizes a strategy to help you pay off and manage existing debts.
- This is one of many debt management methods, but it is not to be confused with the debt avalanche method.
- Using the debt snowball method is relatively simple, but it requires a level of discipline and a thorough review of your current finances and debt obligations.
- The method can be used for both personal and business debts, depending on your financial situation.
The debt snowball method explained
You’ve probably heard of the term “debt snowball method” if you’re looking into ways to help manage your current debts. It’s a popular phrase in which its method is to start by paying off your smallest debt first, then you’ll work your way toward your largest debts, bit by bit (or payment by payment).
It can be a motivating strategy to continue managing your finances and help you put your business in an overall better financial position. Seeing the results of your efforts makes it more likely that you’ll stick with the process and gain momentum by tackling your “easiest” debt obligations and continue rolling onto the next until you reach your financial goals.
How to snowball debt for businesses
Step 1: Evaluate your existing debts from smallest to largest.
The first step is to take stock of your total current debt obligations. Review which items have the lowest amount compared with the largest, and make a list of their order. You don’t need to factor in interest rates for this step, as it focuses primarily on the total amount instead.
Step 2: Make monthly minimum payments for each debt.
Start by making the minimum payment required for each month. This allows you to manage your payments and ensures that you don’t enact any late fees and accrue further debt. You might also consider setting up automatic payments to make this process even easier.
Step 3: Consider areas where you can cut back on spending and save cash.
In addition to minimum payments, you should review your finances and find areas where you can cut spending. Any extra funds you can gather should be put toward the smallest debt you have to pay it off faster.
Step 4: Use funds toward the next debt, once one debt is paid off.
Once you fully pay off the smallest debt, move on to the next and continue making minimum payments with any extra cash you come up with. The key here is to use the funds you were paying with the prior debts, applying them to the next one.
Step 5: Continue paying down debts until they’re all paid off.
If you keep up with your monthly payments and make an effort to provide supplemental funds when you can, you’ll gain momentum — and your payments will “snowball” until you’re debt-free.
Example of how to use the debt snowball method
As a sample of how you might utilize the method, let’s consider the following scenario.
A small business may have an accumulation of various debts that consist of the following:
- $10,000 in credit card debt
- $30,000 in equipment loan debt
- $50,000 in renovation loan debt
Let’s say the company has an average monthly profit of $10,000 and needs to apply this to various minimum monthly payments. For this example, say it owes
- $250 per month for the credit card
- $1,200 monthly for the equipment loan
- $1,750 a month for the renovation loan
In total, the minimum monthly payments are $3,200.
After making these payments and covering the rest of the monthly bills, any excess funds should be applied toward the smallest loan, which, in this case, is the credit card debt. After a few months, the excess cash will have paid off the credit card, so the next debt to tackle would be the equipment loan, followed by the renovation loan.
Pros and cons of the debt snowball method
| PROS | CONS |
|---|---|
| Offers a simple way to track the progress of debt repayment | Has interest rates that may play a role in variable monthly costs |
| Can be motivating and provide a path to financial freedom | May take a long time based on how much debt you actually have |
| May impact your credit score positively with timely payments and lower credit usage | May cost more but is easier to implement than other debt management methods, e.g., avalanche |
Who should use the debt snowball method
The debt snowball method can be used by anyone or any business needing a game plan for better managing their existing debts. It can be particularly useful if you are looking to pay off your debts as quickly as possible and want to be debt-free (even if it costs a bit more to do so).
It is a method that offers a clear step-by-step goal. It can be achieved by those who are motivated and committed to the process, as it does require a level of discipline to ensure success.
Other important considerations of the debt snowball method
There are other considerations to keep in mind when paying off your debts and improving your overall strategy.
Snowball method vs avalanche method
While similar, these two methods are not to be confused or used interchangeably. The snowball method focuses on paying down debts with the smallest balance first, whereas the avalanche method focuses on paying off debts with the highest interest rates first.
Beyond this distinction, they also have different outcomes. With the debt snowball method, you might be able to pay off debts faster, although it may cost you in the long term since it doesn’t factor in interest rates. That said, the avalanche method can save you money by paying off the highest accruing interest first; however, it’s likely to take longer in comparison.
Planning for your future finances
If your efforts in becoming debt-free are successful and you need to secure financing in the future, you should plan accordingly to avoid being subject to a similar situation you were previously in. Before signing the dotted line, you should calculate the cost of debt, estimate your payments, and ensure they align with your current budget. You can also consider whether debt or equity financing might be more suitable for your business needs.
Frequently asked questions (FAQs)
It depends on which strategy better suits your preferences and budget. The debt snowball method might cost more over time since it doesn’t have interest rate considerations at the forefront of its strategy, but you may be able to pay off certain debts faster. The debt avalanche method instead aims to pay off debts with the highest interest rates first, which can take longer but save you money in the long run.
The snowball method is a great way to pay off debt quickly. You’ll have to ensure you keep a close eye on your finances, but if you stick with it, the rewards are certainly worth it to be debt-free.
In terms of the debt snowball method, it’s whichever debt has the lowest amount. To proceed with this strategy, you’ll want to funnel all of your extra funds into this form of debt, and once it’s paid off, you’ll roll extra funds into the next debt, and so on.
Bottom line
If you’re looking to get out of debt, the debt snowball method, made popular by finance expert Dave Ramsey, is one way to help reach your goals. It is a coined term that utilizes a strategy to help you pay off and manage existing debts, and while there are other strategies to consider, this particular method offers a simple and constructive way to help you better manage your finances. The right strategy for you will depend on your overall financial goals and budget.
