This one comes straight from Dave Ramsey, and it’s mathematically WRONG. The fact that it goes against everything your high school math teacher taught you is part of the reason why it works so well!
Before you embark on this Frugal Tip…
Since you’re still reading, I’ll assume that you do have some debt (other than your home). If that’s the case then you need to realize that debt is bad, it is the new form of slavery, and that you need to get out of debt as soon as possible! As Dave Ramsey would say, with “gazelle-like intensity”.
Further, you need to agree that once you’ve found yourself at the bottom of a debt “hole” the first thing you need to do (other than realize you’re in a stinkin’ hole!) is to STOP DIGGING!
At the core, this Frugal Tip really just means paying off your debt. There are two things that make this work,
What’s the trick?
The trick is to pay off your smallest debt first, regardless of interest rates. Yup, even if your smallest debt is at 0.00%, pay it off first!
Why? That doesn’t make any sense! Well, you’re right. It doesn’t make fiscal sense. The longer you hold a high-interest balance the more money you’ll end up paying on it.
So why pay off the smallest amount first? Paying off the smallest amount first does a couple things.
First, and most importantly, it provides an immediate boost to you. It’s an affirmation that you CAN get out of debt. It gives you a few quick “wins” right off the bat.
Second, you’re closing those accounts behind you, which eliminates your ability to “keep digging” in those accounts. It helps you fill in the debt “hole” and ensure that you can’t dig any more in that part of the hole. It’s like filling your debt hole with concrete as you go along.
Third, it gives you funds to apply to your debt snowball, which is what we’ll talk about next.
Why is it called a snowball?
Remember those cartoons when you were a kid where someone would roll a small snowball at the top of a mountain, then roll it down? What happened was humorous at the time, but applicable now. As the snowball rolls it picks up more and more snow, making it bigger and bigger as it rolls down the mountain. Not only that, but the more snow it builds up the faster and faster it rolls!
So how do you apply that to debt?
Pay the minimum payments on all your bills, then scrounge up all the extra money that you can each month (the “initial snowball”), and pay it against your smallest debt until it’s paid off, then close the account.
Next, take your initial snowball, plus the monthly payment of the bill you just paid off, and pay it against your next smallest debt until it’s paid off and you’ve closed that account.
Next, take your initial snowball, plus the monthly payments of the two bills you just paid off, and pay it against your next smallest debt until it’s paid off and you’ve closed that account.
Keep going until you’ve paid off all debt (except your home, you can snowball that later).
How about an example?
That sounds all fine and dandy, but let’s break it down using simulated numbers, shall we?
|Bill||Interest||Balance||Payment||Months to pay-off|
|Loan from Mom||0%||$160||$10||$70 + 10||16||2|
|Credit Card||19.99%||$570||$15||$70 + 10 + 15||38||6|
|Medical Bill||4.25%||$1,000||$100||$70 + 10 + 15 + 100||10||5.13|
|Credit Card||7.99%||$10,000||$250||$70 + 10 + 15 + 100 + 250||40||22.47|
You can see how quickly the snowball effect adds up. To be perfectly honest, there are a few flaws with my example:
- I’m not applying compounding interest to the payoff dates, just to make the math easier,
- In reality, each bill is being paid off in parallel (you’re paying each bill at the same time as all the others), which reduced the overall time to pay-off (that’s a good thing), and
- I’ve applied some rounding, so the figures aren’t exact.
Any way you look at it, by spending that extra $70 per month and snowballing your bills you’ve gone from 40 months to under two years to pay off your (non-mortgage) debt. Meaning, after that 23 months you’ll be saving $375/month. And if you can throw more than an extra $70/month at it, it’ll go all that much faster! Wow!
Don’t squander the money you save after you’ve paid off your bills. But that’s the subject of another Frugal Tip!
|Frugal Tip||Annual Savings|
|How can you Shave and Save?||$27.88|
|Alternate to Shaving Gels and Creams||$47.28|
|TV on YOUR Schedule||$99.00|
|Ditch Paid TV||$359.88|
|Switch to Netflix instead of Redbox to Rent Videos||$150.06|
|Downgrade at-home Netflix, upgrade Streaming Netflix||$96.00|
|Ditch your Land-Line||$552.12|
|Open the Windows||$20.09|
|Make an extra house payment||$2,302.27|
|Snowball your debt||$375.00|
Tune in for our next Frugal Tip! You can thank me later™.