Debt Snowball Strategy – What is It and How to Use It?

Accumulated debt can be a source of great stress and can lead to ineffective financial management. According to a report by Citibank UAE, almost 46% of people in the UAE are currently in debt and around 12% are actively looking to get a loan. With this in mind, it is clear that expert debt reduction and management solutions are essential. The debt snowball method is one of the most widely used debt reduction strategies, helping borrowers not only pay off their debts completely but to also cultivate good financial habits. This article will examine the debt snowball plan, including its advantages, limitations and when it is beneficial to use.

What is Debt Snowball Strategy?

The debt snowball method is a popular way of tackling debt payments, created by renowned finance expert and radio personality Dave Ramsey. It is one of the three most widely used strategies for eliminating loans. The idea is to list all of your debts according to their size, and then use any extra money each month to pay off the smallest debt first. Minimum payments are then made on the remaining debts while this occurs. By focusing on one debt at a time, you can make consistent progress on your financial goals without feeling overwhelmed. Additionally, as each debt is paid off, you can use the money that was being used to pay it off to pay down the next largest debt. This method can help you stay motivated and make tangible progress towards becoming debt free.

How to Use Debt Snowball Plan?

A few simple steps are to be followed for using the debt snowball strategy successfully – 

• The debtor will start by listing their debts in ascending order as per the balance 
• The smallest debt will be picked first and the focus will be on repaying it completely as soon as possible. The debtor can choose to pay a little extra every month or pre-pay a few instalments if their budget allows. 
• The minimum payment due can be made for all other remaining debts on the list 
• Once the smallest debt has been paid in full, the debtor can move on to the next smallest debt in line 
• The same process continues till all the debts have been paid off completely 

Let’s understand this with an example.

Mohammed, a techie in the UAE is currently dealing with four outstanding debts.:

1. AED 5,000 medical debt – AED 50 minimum monthly due
2. AED 3,000 credit card debt – AED 30 minimum monthly due 
3. AED 20,000 car loan – AED 100 minimum monthly due 
4. AED 7,000 personal loan – AED 70 minimum monthly due 

As per the debt snowball plan, Mohammed will first tackle the smallest debt of AED 3,000, the credit card debt, and make efforts to pay it in full. To do this, he may reduce his expenses and allocate extra money towards the debt or do some overtime work to generate extra funds for repayment. Once the credit card debt is cleared, he can move on to the second smallest debt, the medical bill of AED 5,000, and continue in this fashion until his biggest debt, the car loan, is paid off.

The catch here is to stay focused on one goal at a time i.e., by repaying the smallest debt as soon as possible. 

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Advantages of Debt Snowball Plan 

Let’s discuss a few advantages of the snowball debt payoff method of repaying loans and reducing debts:

• Easy to Implement: The snowball debt payoff method does not require any advanced-level calculations. Debtors only need to list their debts in ascending order and start paying them off with the smallest one. The minimum monthly payment required to avoid deferment fees for each loan is already calculated and sent by the lenders.\
• Keeps You Motivated: With small but regular wins in sight, the snowball debt payoff method makes the debtors stay motivated to keep paying off their loans. A debt snowball strategy offers just the right amount of psychological boost required to stay focused when it comes to repaying loans. The disappearing debts reduce stress and help them plan their next steps with a clearer mind. 
• Makes Debt Repayment Manageable: Debt snowball plans are ideal for individuals who have multiple debts and find it difficult to manage payments for each of them. By simplifying the payment schedule, debt snowball not only helps in managing the current obligations of the debtors but also plays an important role in creating good financial habits. 

By the time all debts have been paid off completely, debtors are already in the habit of repaying loans as soon as possible by making extra efforts and contributions. 

Limitations of Debt Snowball Plan

There are certain areas where the debt snowball plan to pay off loans lacks – 

• Does Not Consider APR: The debt snowball method of loan repayment does not consider APR. Since the balance of the loan is prioritised over the interest rate in the snowball debt payoff method, borrowers may end up paying greater interest amounts by the time they completely pay off the debt.
• May Wipe Out Cash Reserves: The debt snowball plan urges the borrowers to devote all disposable income and inflow of money towards paying off their loans. This increases the possibility of emergency funds and savings being wiped out completely or to a great extent. If an emergency arises in the absence after the borrower has already used their savings to pay off the debt, it can make way for additional debt and also set all the progress back. 
• Elongated Repayment Period: Since the smallest debts are paid off first and larger debts are paid off later, the repayment period might end up getting stretched. 

Debt Snowball Calculator 

A debt snowball calculator is an online tool that can be used to calculate the total length of the period it will take to pay off all the active loans and the total interest you will pay during repayment. 

To use a free debt snowball calculator, you will need information like the type of debt (home loan, car loan, credit card loan, and so on), the applicable interest rate, the total loan amount, and the minimum monthly payment of the loan. Simply enter the mandatory information for all the different loans you have and click on the calculate button to get details of your snowball plan. 

Keep in mind that the results may differ as per the calculator you have chosen. Some only show the number of months or instalments it will take to repay all the included debts while others also show the interest amount you will pay, the total debt amount, and the total monthly payment amount. This schedule applies as long you stay on track with all payments for the suggested duration.  

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