Paying off multiple sources of debt might seem like an intimidating task to anyone. The snowball effect is a simple way for you or your spouse to get rid of multiple sources of outstanding debt. You apply a higher payment to the balance of one debt at a time, while maintaining minimum payments on the rest. While the snowball effect is financially sound, its success isn't as much economic as psychological: Quick results can be motivating, say its proponents.
Young adults and married couples who decide to use the snowball effect to pay their outstanding debts need to figure out how much they can pay per month. The best way is to come up with a budget that reveals how much discretionary income you have left over after paying your necessities. For example, if you take home $2,000 per month and your basic living expenses total $1,700, you have $300 worth of discretionary income. Under the snowball effect, you would use that extra $300 to start paying off your debt.
Once you determine how much you can afford to put toward your outstanding debt, the next step is to look at how much you owe. The snowball effect advocates paying off the smallest balances first, regardless of interest rates. According to Dave Ramsey, author of "More Than Enough," it is better to focus on each outstanding debt at one time. The only time you should consider interest rates is when two debts have similar balances. In that case, you would want to focus on the balance with a higher rate.
Each outstanding debt receives the minimum monthly payment, except for the one with the lowest balance. For example, if your total minimum monthly debt payments come to $200, you would continue paying the $200 minimum plus an additional $100 toward the lowest balance. You continue to put the additional $100 against the debt with the lowest balance until it is paid off. As you pay off each debt, the additional payment goes toward the next lowest balance. The total of your monthly payments does not change. It is the individual amounts that you pay toward each debt that change.
As you pay off each debt, it is important to transfer the previous debt's minimum payment toward the next balance. Compound payments are what make the snowball effect so efficient and instantly rewarding. If you have two credit cards, each with a minimum payment of $100, you will want to pay $200 toward one and $100 toward the other. Once you pay off the balance on the card with the $200 payment, you would begin paying $300 toward the second card. You see reductions on a single debt's balance in less time than you would by trying to pay more than the minimum on each card. The main advantage of the snowball effect is a source of psychological reward and motivation, according to Dave Ramsey.
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