This is a guest post from David Brown. He is a content writer with fileyourbankruptcy.org. David writes on a variety of finance related topics with a strong focus on debt.
Are you having debt blues? Have you been hit by the money bug? Are you still paying for some unwise financial decisions? Life can indeed look like a punishment when you are suffocating under the burden of rib crushing, spine tingling debts. However, you can defy financial adversity. If you are armed with proper knowledge then you are bound to get out of debt sooner or later. So what’s your way out of financial trouble?
A much talked about debt reduction method is debt snowball. Quite a few financial experts believe that it can breathe fresh air into your lagging sails. Can debt snowball really get you out of the red zone? Let’s discuss.
What is the debt snowball?
Popularized by the famed financial expert and radio talk show host Dave Ramsey, debt snowball has been embraced by many people who are submerged in debt. How does it work?
Allot as much as possible to the smallest debt while paying the minimums on the rest. Concentrate on the smallest loan to make sure that it is paid off as soon as possible.
After you succeed in paying off the smallest debt, move to the next one. Since you have one less debt than before, you can put the extra money to eliminate it faster. As you clear off your debts one after another, the amount of cash that you can use increases. This helps you to get rid of your debts relatively faster.
By the time you reach the bigger debts, the extra amount that you can pay towards them increases in a quite similar manner to a snowball rolling downhill gathering more snow.
Why should you choose debt snowball?
Debt snowball is certainly an organized and effective way to extricate yourself from debt. It is often applied to revolving debts like credit card debts.
Debt snowball focuses on the emotional side of human beings. “….personal finance is 20% head knowledge and 80% behavior”, says Dave Ramsey. The snowball method correctly assumes that paying off the smaller debts will give you a sense of victory. The early success you get by paying off the smaller debts motivates you to pay off the rest of your debts.
Debt snowball has a significant advantage over the debt avalanche approach by which you need to eliminate the debt with highest rate of interest first. The trouble with avalanche method is that the debt with highest interest rate may also be the one with the highest balance. Is it highly possible that you would plug away at this debt for several months only to give up because of a feeling that you are not getting anywhere. With debt snowfall, as has been stated before, you get “quick wins” which motivates you and keeps you on track.
A secondary advantage of the smallest-balance plan is the reduction of total amount owed to creditors in a single month. This is a risk reduction in the event of a lost job or emergency.
What are the disadvantages of debt snowball?
Debt snowball has been criticized by citing the fact that it is mathematically not the best debt reduction program and does not maximize the use of money. With this method you have to concentrate on paying the lowest balance first regardless of the interest rate. This will cost you in the long run. By giving more stress on “motivational factor” than the interest rate it puts mind over matter which may not be a suitable approach for highly disciplined people.
Another allegation against debt snowball has been that it does not distinguish between secured and unsecured debt. There can be serious consequences if secured loans are not paid in time-foreclosures and repossessions being at the worst end of the spectrum.
Is debt snowball the right choice for you?
Debt snowball is suitable for people who prefer quick results and want a debt reduction plan that is simple to follow. It can be very effective for people who have a wide range of balances. It gives you tangible results and motivation to follow through-something that is missing in many debt reduction methods. Nonetheless, it is not the fastest process of debt reduction and is certainly not the cheapest one.
Debt snowball can be an useful technique to get rid of debt. However, it is important for you to consider the above points and consult a financial advisor before you put your right foot forward. Finally, if you choose debt snowball then make sure that you stick to it till the end of the game. Good luck.
Note from Forest: If you are reading this then you are interested in reducing your debts. I am a part of the Yakezie Personal Finance Blogs network and a fello member Elle has an excellent post on Debt Reduction with her tips and some from other awesome Yakezie members.