Monday, January 31, 2011

The Debt Snowball -- How to Get Yours Rolling

A year ago, we were debt-free (except for the house). We paid off the rest of my student loan, the balance of our credit card, and, finally, the rest of our car loan.  What a feeling!

If you ever listen to Dave Ramsey on the radio, you're probably familiar with the "debt-free scream." You can hear the absolute joy in the callers' voices as they scream that they're debt-free (if you've never heard one of these calls, check it out here).  At first, I thought those calls were a little dramatic, but the closer we got to our debt-free goal, we got more and more excited. When the day came and I went to the Chase bank branch by my house and paid off the car, I walked back to our paid-for car, got inside, and yelled, "WE'RE DEBT-FREEEE!!" My then three-year-old son thought it was hilarious and for about a week or so after would randomly shout, with his arms outstretched above his head, "We're debt-free!" 

And then a few months later both of our cars (with over 200,000+ miles on each) started to show their wear. One of them, the older of the two, couldn't pass the state inspection or emission tests. The newer of the two, a 2002 Subaru, was running pretty rough.  We weighed our options, did the math, and realized that we had to get another car.  So we traded both of the cars in, put down some extra money down on top of that, and financed the rest. As excited as I was about having a dependable, new-to-us (read: used) Subaru and considering we got a pretty good deal, I couldn't help but burst into tears as we drove away from the lot. We were back in debt. However, since we'd tasted that debt-free feeling, we were ready to attack the car debt with, as Dave calls it, "gazelle intensity".

Luckily, we only have one debt to deal with. However, the average American household isn't so lucky. According to an article I found, the average American household carries $8000 in credit card debt. Forty-three percent of households spend more than they earn. In 2003, the average household debt was $18,654 -- which doesn't include mortgage debt. In another article, it says that in 2009, the average college student graduates with $21,000 in student loan debt.  No wonder people feel overwhelmed when it comes to getting out of debt.

That's why I love the debt snowball plan.  I first came across the method in a helpful pamphlet (click here for the online version) when I was a newlywed. Years later, I was reminded of it when my mom introduced me to the Dave Ramsey plan.  The thing I love about this method for debt elimination is that it's simple and straightforward. There are no shortcuts, complicated math, or tricks -- but it works! It's the program we used and I wouldn't recommend anything else.

After you've put aside $1000 in an emergency fund, you're ready to attack your debt (everything besides the mortgage, that is). Gather all your financial info and list all the creditors you have.  Put them in order according to how much you owe, starting with the smallest debt. That's the first debt you're going to pay off. Don't pay attention to the interest rates on each.  This was hard for us at first -- we wanted to pay off our credit card before my student loan. The interest rate on my student loan was only around 3% while our credit card rate was around 10%. But the balance on the student loan was lower than the credit card's (not by a whole lot -- thankfully, I didn't have a huge student loan), so we went with that debt first. Why start with the lowest? Once you pay it off, you gain momentum. You feel the satisfaction of paying off the debt and that feeling keeps you motivated.

When you've figured out the order of how you'll pay off your bills, make the minimum monthly payments on all of them except the first (the lowest). Then, as Dave says, attack that first debt. Once it's paid off, apply the minimum payment you would have been making on that debt and apply it to the second debt.

Here's where the snowball analogy comes into play:  Let's say you've just paid off your credit card to Best Buy (that one seems like a popular place to finance). The payments may have been low, maybe only $20/month. Now that you've paid off that debt, you don't owe Best Buy $20 per month. Instead of using that money in day-to-day expenses, apply it to the next debt. Maybe the second debt is credit card debt. In addition to the minimum payment you owe for that bill (let's say $100/month), tack on the $20 you would have been paying Best Buy. Each payment on your credit card should be a minimum of $120. Then attack the second debt with any other resources you have. Once that debt is gone, apply the minimum from both paid-off debts -- using our example, you'd add $120 to the minimum you owe on your third debt. For a helpful visual for this method, click here for a simple debt-elimination chart. Like a snowball, once you get rolling with this debt-elimination plan, the money that is freed up for paying off debt keeps on adding up.

Make a chart to help you track your progress. Having clearly set and defined goals makes cutting back much easier. When we paid off my student loan, I put the letter saying our balance was paid in full on the fridge. Whenever I saw it, I would get a surge of pride and motivation to keep on with our goals. Do whatever you have to to stay on task. That out-of-debt feeling is worth it!


Heather Dixon said...

I LOVE Dave Ramsey. I listen to his show all the time. Awesome.

Tara said...

We only have car debt but it will be attacked with gazelle intensity this year! We are applying Dave Ramsay to our lives and we are excited!!!

Crystal said...

We had worked hard and sacrificed to be completely debt free as well. And we sold our house that same year, so we really had no debt. Although I am happy to own a home again, now we have a mortgage- our only debt, and it makes me a little sad just to not be totally debt free. It does feel so good to not owe anybody anything. Now its time to start knocking off the mortgage in the same fashion.

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