Part 4 - Organize Your Snowballs
Here are the first three parts of the DIY Money Guy Series: How to Get Out of Debt.
Part 1 – Own Up to Your Debt
Part 2 – Tell People
Part 3 – Why You’re Still in Debt
Part 4 – Organize Your Snowballs
Snowballs. Just the word “snowballs” makes me smile. I think back to when I was a kid having fun playing outside in the snow and having some good snowball fights with massive snow forts with tunnels and all. I learned it was important to have a ton of snowballs made up before hand. Your snow fort needed pretty thick walls so it wouldn’t collapse while also being big enough to duck behind. I also learned that trash can lids make great shields. In a good snowball fight, being well-prepared and having a plan all but ensure your success. Without a plan you are likely to get clobbered and catch a few snowballs in the face. Well, unfortunately that’s not exactly the kind of snowball I’ll be discussing today. But the same goes for money and debt – being prepared and having a plan are the difference in succeeding and getting hit in the financial face. We all know debt sucks! The main reason people are still in debt is because they don’t have a plan to get out of debt. But, before making a plan you first need to STOP spending. Keep your overall goal of being debt free in mind and then work on organizing your thoughts and actions.
Stop Borrowing and Start Organizing
Before you can make a plan for paying off your debt, you need to know exactly what it is that you owe. So how about it, do you know much money you really owe to everyone? The credit card companies, the car loan, that student loan from undergrad, and oh yeah that money you borrowed from your uncle. It can be hard to remember exactly how much you owe, to whom, and when it’s due if you don’t regularly keep track of it. But knowing exactly how much you owe for each debt is definitely something you need to figure out.
There are just four pieces of information you need to know for each debt you have. Gather the following information listed below for each of your debts so you can compare your various debts side-by-side when it’s time to decide which ones to pay off first:
- Name and type of debt
- Current balance - how much you owe on each
- Minimum monthly payment
- Interest rate
The coolest and easiest way to enter all of the above information and see what your plan looks like is with a really cool site called Unbury Us. I typed in some generic names and amounts to show an example of the debts, a graph showing when each debt will be paid off, and total interest paid calculations.
When using this tool or any other one for that matter, don’t forget to include ALL of your debt - credit cards, student loans, car loans, mortgage, payday loans, small business loans, IRS debt, home equity line of credit, personal loans, medical bills, etc. Once you get all of your debt listed it’s time to compare and prioritize them.
The Winter Wonderland of Debt Repayment Strategies
The two most popular approaches for paying off debt are the debt snowball and the debt avalanche. I have no clue what is up with the snow references but that doesn’t really matter. What matters is that both of these methods can and have helped a ton of people pay off their debt much sooner than they ever thought possible. Of the two methods, the debt snowball is the most popular and the method that people are most successful in accomplishing their goal of paying off their debt. Therefore, I recommend the debt snowball approach and will put the most of my focus on it, but I will explain the debt avalanche method so you can learn and understand it as well.
After you have collected the four pieces of information listed above you will have all of the information you need to create your own debt repayment plan. The debt snowball approach is all about gaining momentum similar to a snowball rolling down a hill. The small snowball will eventually grow into a huge snow boulder.
Take all of the information on your debts and line them up in order of balance starting with the smallest balance first. For the debt snowball plan you will be making minimum payments on everything except for your smallest debt or lowest balance. For the debt account with the lowest balance, pay the minimum amount due PLUS an additional hefty chunk every month -- enough to make a solid dent in the outstanding balance. So you will pay off the lowest balance debt off first. Once your debt with the lowest balance is paid off, go onto the debt with the next lowest balance and put all available money towards that debt until it is paid off. Then the next lowest, and so on.
This approach is the most successful because you will see the quick wins of paying off entire balances early and often. The thinking is that it’s motivating to see your debts actually paid off, which makes it more likely that you’ll stick to your repayment plan. With the debt snowball method you will gain momentum very fast and have so much more cash freed up from paying off the earlier debts that it creates the snowball rolling down a hill effect and the amount you can put towards your debt continues to grow until you are finally debt free.
The debt avalanche method focuses on paying off debts in order of highest to lowest interest rate. The size of the outstanding balance of each account doesn’t matter. Mathematically the debt avalanche method is optimized to pay less interest and pay off your debt slightly faster. But it will take significant behavior modification and a solid commitment to you debt repayment plan. While your balance will go down slightly quicker because you pay less interest, it can feel as if the debts are lingering because your account with the highest interest rate may very well be the one with the largest balance. Again compare the numbers using the debt snowball versus the debt avalanche at www.unbury.us to see the detailed breakdown.
Snowball vs. Avalanche
There may naturally be some overlap between the debt snowball and the debt avalanche in whichever approach you decide to take. You could even choose to go with a hybrid version of both. For example, you may have a credit card debt that is your highest interest rate that also happens to be your lowest balance. In this scenario both the snowball and the avalanche method would have you pay off that credit card debt first. Really, the specifics of your plan are much less important than just having a basic plan that you believe in and can stick to. After all isn’t the general goal for all things personal finance to really just make consistent progress toward your goal? Whether that goal is paying off debt, saving up for an emergency fund, or growing your investments – in all of these situations consistent progress will eventually lead you to your goal.
What To Do When…
Like all plans, your debt repayment plan will get tested over time. It is very possible that you may end up changing you plan several times. But any plan is better than not having one at all and just hoping things work out. Having a plan that you can stick to when times get tough will be key to your success. Also keep in mind that life happens along the way. We all know that when we finally feel like we are making noticeable progress towards a goal it seems inevitable that you get sick and have to miss work or your car breaks down and needs some not so cheap repairs. All plans are tested in one way or another. You can and will figure out a way to stick with it even if that means taking a break for a month or two while you get back on your feet.
So go start organizing your snowball so you can learn more, save more, and earn more.