Personal Finance: Budgeting – Part 4, The Debt Snowball

by Jonyce Bullock, CPA

Hopefully by now you are starting to get in the groove of your budget.  You are getting accustomed to tracking your spending and then planning where to spend it, in advance.  Hopefully you’ve found a budget tool that works for you – whether it is a pen and paper, an Excel spreadsheet, or one of the tools from Part 2  of our series. If not, now is a great time to start again.  Don’t let a busy month, avoidance or just procrastination keep you from your goal of creating a budget and getting on the path to financial freedom!

The next step in the budget is to start doing something with the goals that you set over the past few months.  This will vary with each individual and can vary widely from: saving for a vacation, starting a retirement fund, purchasing a new house/car, or paying for an education.  For many, it will include some form of getting out of debt.  Now is the time to start using a “Debt Snowball Plan.”

You have probably heard of a debt snowball plan before. It is a common term in financial planning and is used a lot by financial counselors like Dave Ramsey.  The reason it is talked about so much is because it works!  Talking about and thinking about getting out of debt can be very discouraging.  When you look at a list of debts and payments, it may seem that there is no hope of it ever going away.  Please believe me when I tell you the debt snowball plan works.  I was recently involved in a conversation where it was stated that the problem with financial advice is that it doesn’t work when every penny is already stretched.  The amazing thing about a debt snowball plan is, if you do it in conjunction with a good budget and you are willing to hold yourself accountable, it can work, even with as little as $10 per month to put towards getting out of debt.

Here is how the debt snowball works:  First, make a list of all of your debts, include the debt balances, interest rate, monthly payment amount and remaining payments.  List the smallest balance owed first, followed by the next one, and so forth.  Don’t worry about interest rates – we want to look at which debt you can pay off the fastest.  Next, take the amount extra you can pay each month and add it to the first monthly payment.  List out the payments it will take to pay off the first debt.  Once that debt is paid off take that entire payment and add it to the monthly payment of the next payment.  Continue to do this until all debts are paid off.  Let’s look at an example:  Consider you have the following four debts:

Debts

In this case, you would add the $10 extra per month to your $60 credit card payment, making it $70.  All other payments would remain the same.  The total amount paid each month towards debt would go from $2020 to $2030 per month.  You would continue to do this until the car loan is paid off.  At that point, you start to build some real momentum, by taking the amount of the payment on the car loan and adding it to the credit card payment, bringing the total to $355 per month.  After only 2 months, the remaining credit card balance is paid off.  Next, you add this amount to the student loan and begin paying $455 towards this balance.  After just 13 months, the student loan will be paid off and you can add this amount to the home loan payment, bringing that total to $2030 per month.   During this entire time, your total monthly cash outlay for debt payments never needs to increase.

You may be asking how much of a difference it can make if all you are changing here is $10 a month?  The results are truly miraculous!  By increasing your monthly payment by $10 per month and following the debt snowball pattern, you will save $50,156.12 in interest and it cuts off 89 monthly payments!  If you can find a way to cut another $15 from your budget and increase the amount to $25 per month, your savings will increase to $52,806.37 and cut off 92 payments.  If you were able to increase the amount to $200 per month, you would save $74,962.34 and cut off 123 payments

I know that $200 may not be doable for many budgets, but hopefully $10 is possible.  If you can find a way to cut just $10 from your budget you could save yourself over 7 years of debt payments!    This month’s challenge is to look over what you have been working on the past three months and see how much you can put towards your debt snowball plan and begin putting it to work.  I promise if you do and you are willing to be patient, and hold yourself accountable, the results will be miraculous!

Note:  If you want to try an easy tool to help you map your plan, try the tool located here: http://financialmentor.com/calculator/debt-snowball-calculator

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