The debt snowball method is a debt-reduction strategy, whereby one who owes on more than one account pays off the accounts starting with the smallest balances first, while paying the minimum payment on larger debts. Once the smallest debt is paid off, one proceeds to the next larger debt, and so forth, proceeding to the largest ones last.[1] This method is sometimes contrasted with the debt stacking method, also called the debt avalanche method, where one pays off accounts on the highest interest rate first.[2][3]
The debt snowball method is most often applied to repaying revolving credit – such as credit cards. Under the method, extra cash is dedicated to paying debts with the smallest amount owed.[4]
The basic steps in the debt snowball method are:
In theory, by the time the final debts are reached, the extra amount paid toward the larger debts will grow quickly, similar to a snowball rolling downhill gathering more snow, hence the name.[8]
The theory appeals to human psychology: by paying the smaller debts first, the individual, couple, or family sees fewer bills as more individual debts are paid off, thus giving ongoing positive feedback on their progress towards eliminating their debt.
The debt snowball method goal is to motivate the person in debt to continue paying off the debt. There is a reward to seeing the first smaller debt go away. Feelings is how many get in debt, thus feelings is how one gets out of debt. The plan is easy and simple to follow.[6]
The other method, Debt Avalanche, paying of highest interest rate first, will save the person in interest payment, if they stay motivated. The small debt, with lower interest rate will stay around longer. The debt snowball method has larger high-interest debts around longer, thus may take more time to pay off. [6]
An example of the debt snowball method in action is shown below. In a real payoff scenario the different interest rates on debts will affect payoff times and might make the method less efficient than other plans. However, for the sake of illustrating the method, the example ignores accruing interest.
A person has the following amounts of debt and additional funds available to pay debt (the debt is listed with the smallest balance first, as recommended by the method):
The additional $100 is first directed toward Card A and, together with the $25 minimum payment, pays off the balance in two months. This is illustrated in the following table, with the prioritized debt indicated in bold.
| Month | Card A | Card B | Car | Personal |
|---|---|---|---|---|
| 0 | 250 | 500 | 2500 | 5000 |
| 1 | 125 | 474 | 2350 | 4800 |
| 2 | 0 | 448 | 2200 | 4600 |
Paying off Card A leaves $125 free for additional payment: the original $100, plus the $25 previously committed to minimum payments on Card A. This amount is added to Card B's $26 minimum payment, thereby paying it off in three more months.
| Month | Card B | Car | Personal |
|---|---|---|---|
| 2 | 448 | 2200 | 4600 |
| 3 | 297 | 2050 | 4400 |
| 4 | 146 | 1900 | 4200 |
| 5 | 0 | 1750 | 4000 |
A total of $151 is then free for additional payment, and is applied to the car loan for a total monthly car payment of $301. This pays off the car loan in another six months.
| Month | Car | Personal |
|---|---|---|
| 5 | 1750 | 4000 |
| 6 | 1449 | 3800 |
| 7 | 1148 | 3600 |
| 8 | 847 | 3400 |
| 9 | 546 | 3200 |
| 10 | 245 | 3000 |
| 11 | 0 | 2800 |
The available $301 would then be added to the personal loan's minimum payment for a total payment of $501. This would pay off the personal loan in another six months, leaving the debtor debt-free after a total of 17 months. Since the example omits interest, any payment order could pay off the debts in the same amount of time, but the snowball method avoids long waits between successive payoffs. If the debtor had prioritized debts in the reverse order, the first payoff (Card A) would have taken ten months and the rest an additional seven.
In situations where one debt has both a higher interest rate and higher balance than another debt, the debt snowball method prioritizes the smaller debt even though paying the larger, higher-interest debt would be more cost-effective. Several writers and researchers have considered this contradiction between the method and a strictly mathematical approach. In a 2012 study by Northwestern’s Kellogg School of Management, researchers found that "consumers who tackle small balances first are likelier to eliminate their overall debt" than trying to pay off high interest rate balances first.[9] A 2016 study in Harvard Business Review came to a similar conclusion:
We tested a variety of hypotheses and ultimately determined that it is not the size of the repayment or how little is left on a card after a payment that has the biggest impact on people’s perception of progress; rather it’s what portion of the balance they succeed in paying off. Thus focusing on paying down the account with the smallest balance tends to have the most powerful effect on people’s sense of progress – and therefore their motivation to continue paying down their debts.[10]
Author and radio host Dave Ramsey, a proponent of the debt snowball method, concedes that an analysis of math and interest leans toward paying the highest interest debt first. However, based on his experience, Ramsey states that personal finance is "20 percent head knowledge and 80 percent behavior" and he argues that people trying to reduce debt need "quick wins" (i.e., paying off the smallest debt) in order to remain motivated toward debt reduction. Ramsey Solutions has done studies that show motivation is more effective than interest rates.[11]
Research by Moty Amar and colleagues agreed that debtors are inclined to pay small debts first, which they attributed to "debt account aversion", the desire to reduce the number of outstanding debts regardless of balance or interest expense.[12] However, they also found that when debtors are restricted from fully paying debts and are shown the interest that will accrue as a result of their choice, they make the mathematically optimal decision.[12]