Are you a Robot? If yes, stop reading and use the Debt Avalanche method to reduce your debt.
Are you a human? Continue reading…
The Debt Snowball Method is a debt reduction strategy, whereby one who owes on more than one account pays off the smallest balance first while paying the minimum on all larger debts. Once the smallest debt is paid off, one proceeds to the next smallest debt above that, and so on and so forth, gradually proceeding to the larger debts.
The rolling over of payments from one debt to the next is the Snowball. As one debt is paid off, the payment towards the next debt gets larger. The payments build upon each other as if an actual snowball were pushed down a hill!
The most important word in the above definition is “smallest”. As in smallest debt! Some financial wizards argue it is better to pay off the highest interest rate (Debt Avalanche method). They convince a multitude of people by whipping out their calculator. After a few keystrokes and one look of “See how smart I am?”, they proceed to show you how much interest you could save by paying off the highest interest rate instead of the smallest balance.
They are technically right! One would have to pay slightly more interest expense while using the Debt Snowball (lowest balance) because you’re higher interest rate loans may stay around longer to accrue interest. I’m not confused about how to calculate interest. I’m confused why you care about interest now. If you really cared about interest expense, you wouldn’t be in debt!
Interest is a really sexy thing to talk about. Everyone loves to talk about how much they have been screwed by Corporate America greed. So financial wizards come in to save the day – reduce your interest!
Unfortunately, it’s not sexy to talk about a more important component of debt! Unlike interest, behavioral modification cannot be changed with a few keystrokes on a calculator. It can only be accomplished when your goal is simplified and you are ready for change. I can’t force you to want to become debt free, but I can make the seemingly impossible task of paying off all your debt as simple as it can be. The Debt Snowball takes out judgment and rationalization. It gives you clear cut rules that, if followed, will ensure your meet your destination.
Have you ever wondered how there are hundreds of diets that, although completely contradict each other, help people lose weight? There are diets that suggest a lot of meat. Some suggest no meat. Some suggest high fat. Some suggest no fat. Some suggest high carb. Some suggest no carb. Amazingly they all help people lose weight!
Why? Because “diets” give people purpose, easy to understand instructions, positive reinforcement and feedback. They do not give people paranormal foods! They push people towards behavior that is conducive for weight-loss (consume fewer calories, move more, etc.).
Many diets are just plain wrong (you don’t have toxins in your body unless you eat paint chips!) but they still get people to lose weight because they all possess something way more important than food choices – good behavior.
Debt Snowball is useful for the same reason as a diet! Yes, there might be better mathematical debt reduction strategies, but becoming debt-free is more psychological than it is mathematical. By attacking your smallest debt, you get a quicker reward to reinforce your goal to become debt-free!
Have you ever started a diet and after a month you didn’t lose any weight? No, because you quit that diet after the first week! Imagine having six debts, and after six months you still have six debts. Pretty discouraging! But hey, at least you didn’t pay as much interest expense!
The Debt Snowball is not magic. Paying off the smallest balance first will not work if you keep the same behavior that got you into debt. Paying off the highest interest rate first will not either!
The Debt Snowball in of itself is not the superior debt reduction strategy. It is, however, the strategy that best facilitates decision making that is more conducive for positive behavioral change.
So, exactly what is the superior debt reduction strategy? Changing your behavior!