Debt snowball method: Difference between revisions

Revision as of 02:19, 24 October 2023

Latest revision as of 16:00, 17 August 2025

(24 intermediate revisions by 8 users not shown)

Line 1:

{{Short description|Personal finance strategy}}

The '''debt snowball method''' is a [[debt]]-reduction strategy, whereby one who owes on more than one [[Account (accountancy)|account]] pays off the accounts starting with the smallest [[Balance (accounting)|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.<ref>{{Cite web|url=https://www.daveramseyramseysolutions.com/blogdebt/get-out-of-debt-with-the-debt-snowball-plan|title=How –to Get Out of Debt With athe Debt Snowball Plan|website=Ramsey Solutions}}</ref> 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.<ref>{{cite web|title=Debt Snowball Vs. Debt Stacking|url=http://budgeting.about.com/od/Debt/a/Debt-Snowball-Vs-Debt-Stacking.htm|website=About.com|access-date=2015-06-28|archive-date=2015-06-30|archive-url=https://web.archive.org/web/20150630225639/http://budgeting.about.com/od/Debt/a/Debt-Snowball-Vs-Debt-Stacking.htm|url-status=dead}}</ref><ref>{{cite web|title=How Does Debt Stacking Work?|url=http://classroom.synonym.com/debt-stacking-work-12644.html|website=Synonym.com}}</ref>

{{Multiple issues|

{{Cleanup rewrite|date=April 2023}}

{{Manual|date=April 2023}}

}}

The '''debt snowball method''' is a [[debt]]-reduction strategy, whereby one who owes on more than one [[Account (accountancy)|account]] pays off the accounts starting with the smallest [[Balance (accounting)|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.<ref>https://www.daveramsey.com/blog/get-out-of-debt-with-the-debt-snowball-plan – Get Out of Debt With a Debt Snowball</ref> 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.<ref>{{cite web|title=Debt Snowball Vs. Debt Stacking|url=http://budgeting.about.com/od/Debt/a/Debt-Snowball-Vs-Debt-Stacking.htm|website=About.com}}</ref><ref>{{cite web|title=How Does Debt Stacking Work?|url=http://classroom.synonym.com/debt-stacking-work-12644.html|website=Synonym.com}}</ref>

The debt snowball method is most often applied to repaying [[revolving credit]]{{snd}} such as [[credit card]]s. Under the method, extra cash is dedicated to paying debts with the smallest amount owed.<ref>[http://www.allaboutmoney.com/debt-advice/debt-snowball-0-2646.htm "How a `debt snowball` plan works"] {{Webarchive|url=https://web.archive.org/web/20140222055100/http://www.allaboutmoney.com/debt-advice/debt-snowball-0-2646.htm |date=2014-02-22 }}, All About Money</ref>

==Methodology==

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

# 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.

# Commit to pay the minimum payment on every debt.

# Determine how much extra can be applied towards the smallest debt.

# 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.

# 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.

# Repeat until all debts are paid in full.<ref>{{Cite web|url=https://www.ramseysolutions.com/debt/how-the-debt-snowball-method-works|title=How the Debt Snowball Method Works|website=Ramsey Solutions}}</ref><ref name="auto">{{Cite web|url=https://www.investopedia.com/terms/s/snowball.asp|title=Debt Snowball: Overview, Pros and Cons, Application|website=Investopedia}}</ref><ref name="auto1">{{Cite web|url=https://www.bu.edu/questrom/2017/01/05/paying-back-those-swipes/|title=Paying Down Credit Card Debt &#124; Questrom School of Business|website=www.bu.edu}}</ref>

# 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.<ref>{{Cite web|url=https://www.usatoday.com/money/blueprint/debt/debt-snowball-method/|title=What’s the debt snowball method?|first=Erin|last=Gobler|date=August 10, 2023|website=USA TODAY Blueprint}}</ref>

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.

==Pro and cons==

*Pro:

The debt snowball method goal is to motivate the person in debt to continue paying off the debt. There is an emotional reward associated with quickly paying of a small debt, which can motivate people to continue with the plan.<ref name="auto"/>

<br>

*Cons:

Debt Avalanche, in contrast, focuses on paying of highest interest rate first and will result in less payments to interest assuming one follows through with the plan. The small debt, with lower interest rate will stay around longer. The debt snowball method has larger high-interest debts around longer, thus may take more time to pay off.<ref name="auto"/>

<br>

*In either method, fixing the cause of the debt (this does not include one's home loan) must be addressed, that is balance of income vs spending.<ref name="auto1"/>

==Example==

Line 105 ⟶ 110:

==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. evenFrom thougha purely hypothetical perspective paying the larger, higher- interest debt would be more cost-effective., Severalthough writersthis andline of reasoning also assumes mathematical factors are more important than behavioral or emotional factors in reducing unwanted debts.

Several researchers have consideredfound thisthe contradictionsnowball betweenmethod is more likely to lead to debt elimination, despite the methodsnowball's andperceived flaws when considered from a strictlypurely mathematical approachperspective. In a 2012 study by Northwestern’sNorthwestern'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.<ref name=Boyer2012>{{Cite web|url=http://www.kellogg.northwestern.edu/news_articles/2012/snowball-approach.aspx|title = The 'snowball approach' to debt - Kellogg School of Management}}</ref> A 2016 study in ''Harvard Business Review'' came to a similar conclusion:

{{block quote|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’speople's perception of progress; rather it’sit'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’speople's sense of progress – and therefore their motivation to continue paying down their debts.<ref name=Trudel2016>{{Cite news|url=https://hbr.org/2016/12/research-the-best-strategy-for-paying-off-credit-card-debt|title=Research: The Best Strategy for Paying Off Credit Card Debt|work=Harvard Business Review|access-date=2017-03-17}}</ref>}}

Author and radio host [[Dave Ramsey]], a proponent of the debt snowball method, concedes that an analysis of maththe subject from a purely mathematical and interest rate perspective leans toward paying the highest interest debt first. However, basedRamsey onalso states his experience, Ramsey statesopinion that personal finance is "20 percent head knowledge and 80 percent behavior" and he argues that people trying to reduce debt often need "quick wins" (i.e., paying off the smallest debt) in order to remain motivated toward debt reduction. Ramsey Solutions has done internal studies which found debt snowball method tends to be more effective in real-world situations.<ref name=Ramsey2009>Dave Ramsey (2009). The Total Money Makeover: A Proven Plan for Financial Fitness. Thomas Nelson Inc, {{ISBN|978-1595550781}}</ref>

Research by Moty Amar and colleagues agreed that debtors are inclined to pay small debts first, which they attributed to "debt account aversion", i.e., the desire to reduce the number of outstanding debts regardless of balance or interest expense and focus on a "tangible sense of progress".<ref name=Amar>{{cite journal |doi=10.1509/jmkr.48.SPL.S38 |ssrn=1760528|title=Winning the Battle but Losing the War: The Psychology of Debt Management|year=2011|last1=Amar|first1=Moty|last2=Ariely|first2=Dan|last3=Ayal|first3=Shahar|last4=Cryder|first4=Cynthia E.|last5=Rick|first5=Scott I.|journal=Journal of Marketing Research|volume=48|pages=S38–S50|s2cid=55616109}}</ref> However, they also found that when debtors in a laboratory simulation are restricted from fully paying off small debts in full, and are instead shown the interest that will accrue as a result of their choice, they tend to make the mathematically optimal decision.<ref name=Amar/>

Research by Evan McAllister, based on survey and research data from the Federal Reserve, found a slight majority of people report the avalanche is more effective than the snowball. McAllister adds the snowball may be more effective for some people, and has the added benefit of potentially helping change financial habits for the better.<ref>McAllister, Evan, "A snowball's chance: Debt snowball vs. debt avalanche" (2018).Senior Honors Projects, 2010-current. 699.https://commons.lib.jmu.edu/honors201019/699</ref>

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.<ref name=Ramsey2009>Dave Ramsey (2009). The Total Money Makeover: A Proven Plan for Financial Fitness. Thomas Nelson Inc, {{ISBN|978-1595550781}}</ref>

A 2023 paper by Nurazleena Ismail and Hilmiah Ahmad stated both avalanche and snowball methods have their merits and shortcomings, and also noted reducing unwanted debt levels had cognitive elements that can be as important as mathematical analysis. The authors cited [[nudge theory]] to argue individual personality traits must be considered and there is no ideal debt payment method that will work for everyone in all scenarios.<ref>Ismail, Nurazleena, and Hilmiah Ahmad. "Consumer Debt Management among Government Employees: Cognitive, Emotional and Behavioural." e-Academia Journal 12.2 (2023).</ref>

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.<ref name=Amar>{{cite journal |doi=10.1509/jmkr.48.SPL.S38 |ssrn=1760528|title=Winning the Battle but Losing the War: The Psychology of Debt Management|year=2011|last1=Amar|first1=Moty|last2=Ariely|first2=Dan|last3=Ayal|first3=Shahar|last4=Cryder|first4=Cynthia E.|last5=Rick|first5=Scott I.|journal=Journal of Marketing Research|volume=48|pages=S38–S50|s2cid=55616109}}</ref> 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.<ref name=Amar/>

==See also==

*[[Personal finance]]

*[[Alternative financial service]]

*[[Debt consolidation]]

*[[Debt management plan]]

==References==

Line 122 ⟶ 135:

[[Category:Debt]]

[[Category:Personal finance]]