Accelerate Your Debt Pay-off with a Debt Snowball
Option two for debt reduction involves the application of a simple, yet tried and true, principle with many names. It has been called a roll-down, a roll-up, a snowball and several other strategies.
This principle essentially requires that you change some of your current spending habits without spending any more on debt than you do at this time.
This powerful principle is best illustrated through an example. Let’s say that this table is a person’s debts
DEBT Balance Interest Rate Monthly Paymt.
Car Loan 1 13,560 7% $340
Car Loan 2 9,400 9% $200
Discover Card 3,100 16% $80
Mastercard 850 18% $50
Student Loan 23,900 1.50% $150
Mortgage 1 189,000 6.25% $1,200
Mortgage 2 49,000 7% $800
Total Monthly Payment $2820
If you simply follow your lenders’ plan for your debt pay-off, you will simply be making minimum payments, accruing interest steadily, and will basically be under great financial stress.
So let’s begin with the current monthly payment toward debt: $2820. Remember that lenders want to keep your balances up for as long as possible, because that’s how they keep earning money.
You want to get rid of balances in a hurry.
Your best bet is to restructure your payments so you get rid of balances quicker, and you can do this without paying anything extra toward debt.
What would happen if you paid $50/month toward your student loan for six months or so, and took that extra $100 and applied it toward your Mastercard?
Your Mastercard would be paid off in six months. Then you commit to not carrying any balances on that card ever again. Dave Ramsey would tell you to cut up the card and use cash only, we tell you to hold onto it so you can use it more wisely down the road.
With your Mastercard paid off, now you have $150 that you can apply to another debt. Shift that $100 back to your student loan, and then apply $50 to your next credit card.
Adding $50 to your Discover Card payment is going to pay that balance off several months early, thus freeing up another $80 dollars to apply toward another debt.
Now you’ve got no balances on credit cards, and you are applying the $50 from the Mastercard and the $80 from the Discover Card to another debt… say your first car loan. So now instead of paying $340 on your car loan each month, you are paying $470!
Your balance will reduce quicker and interest will not accrue as fast on that shrinking balance.
This is called a debt roll-up, or a snowball.
Obviously, you still have to pay off your debts, and what is equally obvious is that you will still be in debt for several years. However, consider what would happen if, in 4 years, you paid off every debt except your two mortgages.
You will have freed up an extra $820 that you can pay directly toward mortgage principal every month. Now you’ve accelerated your mortgage pay-off to incredible speeds! In fact, you will be paying an extra $9840 towards your mortgage principal every year!
With the principal shrinking so fast, interest will accrue slower and you will be saving even more money. At this rate, you are going to be out of debt in about nine more years.
That’s right, you will own your homes straight up and you will not have any other debts in about 13 years!
There is plenty to more to say about debt pay-off, particularly about some advanced debt modification strategies. We will cover those issues in future lessons.