Thursday, January 29, 2009

Getting out of Debt: The Debt Snowball

A little over a week ago we had a freak snowstorm here in North Carolina. Four inches later, all the kids in the neighborhood were in their yards sledding on trashcan lids and using beach toys to gather up the white stuff for snowballs. Some of the kids had never seen snow, but they all wanted to build snowmen.

The first step to building a snowman is gathering up that chunk of snow that you can start rolling across the ground. The more you roll, the bigger the ball gets. Before you know it, there’s a real-life Frosty keeping watch over your home. Those kids were rolling snowballs all over the ground, delighted to see them grow larger and larger.

Being a financial coach and certified nerd, I immediately linked the snowman process to dumping debt for good. I teach clients a process called The Debt Snowball for completely eliminating their consumer debt – typically in 24 months or less. Here’s how it works:

With the debt snowball, you list the debts from smallest payoff to largest. While paying minimums on everything else, you attack the smallest debt with such a vengeance that it can do nothing but hit the bricks. I’m talking about selling stuff, tightening the budget to free up cash, and doing whatever else you can to kick that first debt out of your life for good.

Once the smallest debt is gone, you take the minimum amount you used to pay on it and roll it into the payment on the next debt – along with any other funds you can free up. Remember, we’ve already discussed putting your foot down and being done with debt; your ferociousness can shine in all its glory now. Once that second debt is paid off, you roll its payment, the first debt’s payment, and any other cash you can scrape together into the third debt. Just like a snowball for a snowman, as you pay off a debt and roll the funds into the next, your payments get larger and larger.

But, why wouldn’t you pay off the debts in order of interest rate – from highest to lowest? I get this question all the time. Personal finance is much bigger than numbers and interest rates. We’re talking about emotions and behaviors here. It’s personal. If the debt with the highest interest rate has a huge balance, it’s going to take a while to pay it off. It won’t take long before you lose your enthusiasm and motivation. But when you taste some victory by paying off a small debt you’ll be invigorated to push forward and kick that next one out of your life.

I’ve worked with people who were able to throw thousands of dollars each month at their largest debts after they’ve gotten rid of smaller ones. That’s a huge snowball rolling downhill, destroying every debt in its path! Thousands of others across the country have used this process to achieve debt freedom, so what do you have to lose? Debt.

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