Before beginning, you should be able to check off all of the following.
- I have no credit cards in my wallet or purse.
- There’s no sense in paying them off if you just build the debt back up again!
- I use a debit card for all normal purchases while I’m out.
- I have set up automatic payments for all regular expenses, including credit cards and rent.
- I have at least $1,000 in an emergency fund.
- I am transferring at least $100 per month into the emergency fund.
Note: If your emergency fund falls below $1,000 then stop making extra payments and re-build up your emergency fund. Having an emergency fund is a non-negotiable prerequisite for this step!
Having automatic payments setup isn’t absolutely necessary as a prerequisite, but highly recommended because missed payments cause useless fees that will melt your snowball and turn it into a fiery ball of molten death that will crush your spirit and burn your progress to ashes.
First, find some get-out-of-debt money. This is extra money above your minimum payments that you’ll use each month to pay off your debts. It could be $100 or it could be $5. Every bit counts.
In this step, we’ll be paying off your credit card debt, student loans, medical bills, car loans and the like. We will not yet pay off your mortgage.
- Order your debts from the lowest to highest balance.
- Make minimum payments on all of your debts, except the one with the lowest balance.
- Use your get-out-of-debt money to pay down the lowest balance first.
- When the lowest debt is paid off, the entire amount that was being paid towards it is used for paying off the next lowest debt.
- Repeat starting at step 2.
As you can see, you’ll be making all minimum payments except for on the debt with the lowest balance. That debt is where any extra cash will go. This will result in paying off one of your debts very quickly. For the next debt, you do the same thing, but this time you add the entire payment amount used towards the old debt and you add it to paying off the current debt. By the end of your snowball the payments you’ll be making each month will be huge. Try the Debt Snowball calculator to see how it will work for you.
What It Feels Like
Before you begin it may seem like you’re getting nowhere at all. Hang in there. This is a proven method.
Once you payoff your first debt and start making a larger payment on your second debt you’ll see with your own eyes how powerful this is. What’s awesome is that even though the amounts you pay towards your debts become huge at the end of your Snowball, it’s not money that you miss. That money was already going towards your debts! Now it’s being focused.
The Other Way
If you decide to research this repayment plan you’ll find two things. 1) Everyone says it works very well, and 2) a few people here and there say it’s not the most efficient method to pay down your debt. The naysayers say that instead of ordering by lowest balance to highest balance, you should order by highest interest rate to lowest interest rate. Thus saving yourself some interest in the long run. The cases where this makes a difference are rare. While in some cases you can save in interest payments over a long period, it is much more important to see the debts being paid off as fast as possible and to stay motivated. Even though a few people say the Snowball method isn’t the most efficient, most of those same people still believe it’s the best method! I think it’s the best method too. Stick to the Snowball and watch your debt disappear faster!
Pay Off or Invest?
What if I have a very low interest rate loan and I could get a better return investing? Should I invest the money instead of paying off the loan?
No. Investments have risks and paying off your loan has no risk. Also, it usually makes better financial sense to pay off the loan even if the interest rate is very low. Comparing paying off a debt to investing in a 401K isn’t really comparing apples to apples, for example, because the 401K money can’t be used without penalty until retirement. Investing also doesn’t change your debt to income ratio which affects what kind of loans you may be approved for in the future.
You can use this online calculator to determine what the financial difference really is over the longterm (https://studentloanhero.com/calculators/student-loan-payoff-vs-invest-calculator/). It compares the return on investment between paying off the loan early and investing. It doesn’t address how it feels to pay off your debt though. Even if in some cases it may be slightly better to invest your money and carry the loan, it will take much more time for that better return to come to fruition (it takes the remaining life of the loan). Also, do you know what to invest in? Have you considered inflation when entering your projected investment return? Paying off all of your debts except your mortgage is a good plan. In the words of Robert Deniro’s character Sam in Ronin, “lt’s a good plan. Let’s stick to the plan.” The answer is the same for someone with employer matching on a 401K – payoff the loans before investing.
You’re Done When
- You have no non-mortgage debt. No credit cards, no student loans, no car loans, no medical bills.
Info – Insurance Etc.
There isn’t much content in this Info section because this isn’t a guide on insurance. Plus insurance is soooooo boring. There are some important things to say however.
1. Get health insurance.
If you don’t have it then the result on your finances can be devastating. If you’re not sick all the time then get the largest deductible possible so that the premiums are cheaper.
2. Verify or purchase health insurance when traveling abroad.
3. If your parents are alive, consider discussing long term care insurance with them.
Long term care for the elderly can cost anywhere from $40,000 per year to $90,000 per year. It varies greatly based on the level of care that’s needed, of course.
4. Create a will, if you care about things like who takes care of your children when you die.
5. Do NOT use insurance as an investment.
The products known as “cash-value” policies are scams, because the return on investment is so low and the charges are so high.
6. Do not buy extended warranties.
Don’t forget to set up automatic payments for these bills as well!
Continue Your Journey
Make me happy by leaving feedback using the form below and you’ll be sent to Step 6 when you’re done! Or continue to Step 6 without leaving feedback :(.