By John Clark
The debt snowball approach to reducing debt is fairly simple, but is it advisable?
Although some financial advisors advocate it, for many people in danger of bankruptcy, it may only be a quick fix with little or no lasting benefits.
With the debt snowball plan, debtors gather their debts and organize them in order of balances, rather than interest rates.
While common sense tells us to pay off the highest interest debts first, the snowball logic goes in the other direction.
Debtors who use the snowball method start off by paying only minimum payments on all debts except the one with the smallest balance.
The idea is to take the cash that would have been dispersed across other accounts by paying more than the minimums and apply it to pay off the smallest debt quickly.
After the smallest debt is paid off, the debtor moves on to the next smallest debt and does the same thing until it is also paid off.
The idea is to gain momentum with debt reduction, moving up to conquer larger debts one step at a time.
It’s exciting to see a zero balance and finally paying off a debt can be very gratifying, but could the excitement be truly unfounded?
The problem with the snowball approach is that while debtors may become excited about knocking out smaller balances, their actual total amount of debt may increase.
If larger amounts of money are owed on high-interest loans and credit cards, the amount of interest continues to increase these debts each month.
When payments are slashed to the minimums, these debts grow quickly and can offset the benefits of paying off a smaller debt first.
Paying down high-interest debts first generally makes more sense as it can more effectively reduce the total amount of debt.
Although the snowball method may appear to show results quickly, debtors must look at the big picture to get an idea of whether the debt snowball is an effective solution.
Paying smaller debts first may make no difference in the total amount of debt owed if no attention if given to larger and higher-interest debts.
Some people are in debt because of the desire for instant gratification. The snowball plan feeds that desire.
If a debtor remains excited about the perceived results of the snowball plan, they may ultimately be able to conquer larger debts. However, while it feels easy and satisfies a need for quick results, a closer look may be more disappointing.