Debt Snowball Strategy – Easy way to repay Loans

When you take some snow in your hand, make a ball out of it and let it roll in the snow, the ball becomes bigger and bigger. You get a big snowball without attempting to make one. This snowball strategy can be used to pay off debts. It is good to pay off your debts as you will be in better shape from a financial perspective. Let us see how the debt snowball strategy works. In this strategy –

  1. You have to list down all your debts from the smallest one to the biggest one in terms of amount irrespective of the interest rate.
  2. Then you allocate money to each of them such that minimum payments are done for all loans except the smallest one. The smallest one gets the biggest chunk of the payment that can be made. Once the minimum amount is paid for all other loans, make the minimum payment for the smallest one and some extra payment as well if possible.
  3. Keep doing this till the smallest debt is paid off. Then you have 1 loan less. Then you pay off the other loans in the same manner by paying minimum amounts for all loans except for the debt of the smallest amount now and pay as much as you can towards it.

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In this way, the number of loans will start reducing and at the same time, the amount to be paid for loans will also decrease as you are making a payment towards each of them. You will be on a roll like a snowball by eliminating debts one by one.

Here is an example wherein it is assumed that the borrower has an amount of Rs.8000 to pay in every cycle –

Cycle 1

DebtAmount to be paidMinimum Amount that should be paid regularly
Credit Card PaymentRs. 600 (Minimum amount to be paid is Rs. 200)Rs. 200 (Pay the additional Rs. 100)
Personal LoanRs. 1,00,000  (Minimum Amount to be paid- Rs. 2700)Rs. 2700
Student LoanRs. 2,00,000 (Minimum Amount to be paid- Rs. 5000)Rs. 5000

 

Cycle 2

DebtAmount to be paidMinimum Amount that should be paid regularly
Credit Card PaymentRs. 300 (Minimum amount to be paid is Rs. 200)

(*Interest charge is not considered here.)

Rs. 200 (Pay the additional Rs. 100)
Personal LoanRs. 1,00,000  (Minimum Amount to be paid- Rs. 2700)Rs. 2700
Student LoanRs. 2,00,000 (Minimum Amount to be paid- Rs. 5000)Rs. 5000

 

Cycle 3

In this cycle, the credit card payment will not appear, as the outstanding amount has been paid

DebtAmount to be paidMinimum Amount that should be paid regularly
Personal LoanRs. 1,00,000  (Minimum Amount to be paid- Rs. 2700)Rs. 2700 (The balance of Rs. 300 should be paid to this loan).
Student LoanRs. 2,00,000 (Minimum Amount to be paid- Rs. 5000)Rs. 5000

 

Check:- Read this before you take Education Loan

This strategy keeps you motivated as when you follow it, the loans start to disappear one by one which makes you happy. You will see the plan working and stick to your payment schedule strictly. If you follow your payment schedule strictly, you will soon become debt-free.

There are some criticisms of this method. For example, it does not consider the interest rate of the loans. Some loans have high-interest payments. Credit cards, for example, have very high-interest rates and it might be a better option to pay off the credit card bill in one go otherwise the interest accumulated becomes a huge sum to pay off.

There is another strategy of paying off debts which is called the avalanche strategy wherein the loan with the highest interest rate should be paid off first. This also makes sense as the interest payment on a credit card is quite high and if you ignore it, over time, the amount to be paid becomes quite high.

Also Read:- What is Planning Fallacy and how it affects your Finances?

The debt snowball strategy works as it gives you emotional encouragement when you see the number of debts reducing and personal finance is a lot about motivation and behavior. If you see your debt reducing, you will be encouraged to be disciplined about your finances. The Avalanche method helps to finish off debts slightly earlier as it targets loans with higher interest rates first.

I think we should use a mix of both methods to pay off debts. Comment your opinion on this.

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