BALANCE FOCUSED
DEBT MANAGEMENT PLAN

Not all debt is bad debt, but most debt involves you paying someone back more than you borrowed. Once you find yourself in any kind of debt, lowering the extra amount you are paying back will eventually get you to a point where you can keep that money for yourself. The one constant thing you should always do is to make all the minimum payments you need to and then develop a plan to lower your debt with any extra money you can afford to pay. One of the two main approaches you can use to accomplish this is the Snowball Method. People choose this method because this is the most motivational approach to paying off debt and at the end of the day a plan is only successful if it is actually executed. 

WHAT IS IT?

The Debt Management Plan Snowball Method is a method that requires you to arrange all your loans from the smallest balance amount to the highest balance amount. With this plan, any extra money that you can afford to spend on making loan payments should be made on the smallest balance loan. Once that loan is paid off, you now take the monthly payments you would have made for that loan, plus any extra money that you can afford to spend on making loan payments and apply it to the next loan that is the new smallest balance loan. This method allows you to lower the total number of loans you have to pay off the fastest. As you pay off each loan, it frees up that money to now be applied to the next loan instead which snowballs your payments to be larger and larger the more loans that you pay off. People find this method to be the most motivational because they find completely paying off a debt encouraging and want to continue feeling this sense of accomplishment as they focus on paying off more of their loans. 

Loan Examples

            The example of loans listed below will be used to review the snowball debt management method. Let’s say someone has the following loans:

• A Credit Card with a balance of $500 which requires a monthly minimum payment of $15 and has an Annual Percentage Rate (A.P.R.) of 20%. 
• A Car Loan that has a balance of $20,000 which requires a monthly payment of $500 and has an Annual Percentage Rate (A.P.R.) of 4%.
• A Mortgage that has a balance of $250,000 which requires a monthly minimum payment of $2,000 and has an Annual Percentage Rate (A.P.R.) of 6%.

Snowball Method Applied

Using the loan examples described, to approach paying off the debt with the Snowball Method, you would first arrange the debts from the smallest balance amount to the highest balance amount which would be:

• $500 balance Credit Card with a $15 monthly minimum payment
• $20,000 balance Car Loan with a $500 monthly minimum payment
• $250,000 balance Mortgage with a $2,000 monthly minimum payment

Note: The Annual Percentage Rates (A.P.R.) of the loan is not a factor that is considered in the Snowball Method.

Let’s assume you review your finances and realize that you have a total of $3,000 that you can afford to spend on your loan payments this month. You would first make your monthly minimum payments so after the $15, the $500, and the $2,000 payments, you would have $485 extra that you can apply to your loan payments. With the Snowball Method, you would apply it to your smallest balance loan of the Credit Card. Next month, with the Credit Card paid off and assuming that you still have $3,000 that you can afford to spend on your loan payments, you would make your monthly minimum payments of $500 on the car loan, and $2,000 on the mortgage and apply the remaining money to your new smallest loan the car loan. You would now have $500 extra that you can apply to your loan payments since you no longer need to make payments on the credit card because you have freed up the $15 you would have paid as a minimum payment on the credit card. Finally, you would only have the Mortgage left and you could now make monthly payments of $3,000 to it until that loan is paid off. Your payment on a particular loan gets larger after you pay off a smaller loan and redirect those payments to the new loan; this is similar to how a snowball gets larger the more snow you pack on to it.

Any self-help book that you read that gives advice on getting debt free is going to encourage you to take the Snowball Method approach. Having fewer loan payments can certainly lower stress and this method works quickest to lower the number of loans that you have. As each loan is paid off you tend to get encouraged and be more motivated to continue. This is why self-help books will promote this approach because getting you motivated about eliminating debt gets the reader to feel as though the book is providing great advice.

The Snowball Method only works if you follow through with the plan. If you eliminate a small debt, sure it leads to feeling less stressed, but if you do not apply the payments you use to make to that account to the new smallest loan then you will not pay off your debts faster. Additionally, if feeling less stressed about having fewer loans leads to you taking on new debt by taking out a new loan or more debt by putting charges on a credit card that you had already paid off, it will now actually take you longer to pay off your debts. Alternatively, the Avalanche Method to debt management may help you pay off your debt faster and can avoid the possible shortcomings of this plan. 

Why should I make the monthly minimum payments on all loans, can’t I just put all the money I have for loan payments on one loan at a time?

When you are late on payments or miss payments all together, the added fees and interest will make the amount that you have to pay back larger and as a result it will take you even longer to pay off the loan now. This will most likely also lower your credit score, which will impact your future ability to get new loans and will lead to loans with a higher Annual Interest Rate (A.P.R.). This will ultimately lead to your current loans and future loans taking even longer to pay off because you are paying higher interest. Therefore, no matter which debt management plan you choose, the one thing that stays constant is that you should always make all your minimum payments.

How should I apply my payments that are in addition to the minimum payment?

Make sure that the additional payments that you are making are being applied the way that you intend. For example, some loan holders will not apply partial payments. This means that if your normal minimum monthly payment is $2,000 and you decide to pay an additional $50, this may not get applied to your payments because it is only a partial payment and not a full $2,000 payment. The loan holder will apply a payment once the remaining funds of $1,950 have been collected from you. You may need to directly contact the loan holder and ask them to apply your payment as a principal only payment. This will directly lower your total loan amount, without impacting the monthly minimum payment. For example, if your total loan amount left is $10,000 and you make a principal only payment of $100, this will adjust your new total loan amount to have a balance of $9,900. Any interest that is charged will now be evaluated based off the $9,900 balance and not the $10,000 balance, which ultimately will save you money in interest. 

Other Debt Management Plan: Avalanche Debt Management Plan