Paying off debt can be one of the most daunting tasks of anyone trying to clean up their financial mess. I know because I am in the middle of reducing my debt from a high of $120,000 at the beginning of 2013 (currently at about $90,000. You might not know where to start? Do I pay off the highest interest first? My house? My car? My credit cards, etc?
There are dozens of articles on how to pay off debt. Some advocate you start with credit card debt. Some recommend that you focus on the highest interest rate first, etc. However, the best way to pay off debt is the debt snowball method.
If you are a fan of Dave Ramsey you have probably heard him talk about the snowball method of paying off debt. Dave makes it part of his baby steps. Now I am not a fan of everything he has to say and frankly his politics gets under my skin, but his steps to get out of debt and build wealth is a great place to start.
The Debt Snowball Method
The debt snowball method is pretty simple. It is essentially where you take all of your debt, excluding your house and put them in order of balance. The interest rate on credit cards DOESN’T MATTER! List them all smallest to largest.
Then when you make your monthly payments on the debt pay minimum payments on all of your debt except that smallest debt and put as much money as you can on it. Obviously, you pay your normal bills first and it is whatever money you have left over. You do this until you eliminate that debt. Then take that payment on the smallest debt and then move to the next smallest. Then when you pay that off you go to the next debt and so forth.
The idea is that by paying off those small debts (e.g. small store cards, maybe some small medical debt, a personal loan, etc) first you gain momentum. The more momentum you have the faster you get out of debt.
Pretty simple, not difficult to master, but highly effective.
How Do We Know It Is the Best?
Well, I am not good at a lot of things in life, but I am pretty good at research. And like a lot of things I do my research. Research studies have found that the Debt Snowball is the best method for paying off debt. The latest one was widely reported in 2012 when researchers from Northwestern University found that Ramsey’s method was the most effective.
Mathematically, the debt snowball isn’t the best method. However, paying off debt is also a change in behavior. Too many people get frustrated by larger debts and don’t gain traction. The beauty of the snowball method is that you gain quick wins that continue your momentum and you begin to change your behavior.
Now none of this works if you just continue your old habits. The key is you need to commit to pay off debt, budget, and change.
The Bottom Line
When you read about paying off debt you will hear about the debt avalanche method, debt snowflake, etc, etc. The Debt Snowball is the best.