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Dave Ramsey Debt Snowball Payoff Strategy

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Snowballs Start SmallDave Ramsey is most well known for an idea known as a “debt snowball” repayment plan. The idea taps into human psychology and our desire to reduce the number of something, even if the sizes of those “somethings” vary (more on this idea this afternoon). While it may not be the mathematically optimal strategy, and everyone agrees on this, it’s one that has seen great success over the years.

The basic premise is that you make minimum payments to all of your debts and put any extra debt repayment dollars towards your smallest debt. As you retire debts, you take those minimum payments and apply them to the next smallest debt. In this manner your small minimum payments “snowball” so that as you near the end, your payments are much larger than the remaining minimums.

Example Debt Snowball

Let’s say you have five loans:

  • Student loan: $25,000 @ 6% APR
  • Mortgage: $100,000 @ 5% APR
  • Credit card A: $9,000 @ 19.99% APR
  • Credit card B: $8,000 @ 19.99% APR
  • Car loan: $5,000 @ 6% APR

First, you list all of your debts starting with the smallest balance to the largest:

  • Car loan: $5,000 @ 6% APR
  • Credit card B: $8,000 @ 19.99% APR
  • Credit card A: $9,000 @ 19.99% APR
  • Student loan: $25,000 @ 6% APR
  • Mortgage: $100,000 @ 5% APR

First, you make minimum payments on every debt so you are current and suffer no penalties, fees, or other adverse effects. If you have an extra $100 each month left over for debt repayment, you put it towards the Car loan because it’s the smallest debt. Once you retire the car loan, take it’s minimum payment and put it towards Credit Card B. Once Credit Card B is retired, go after Credit Card A.

Not Optimal, but Effective

Why is the debt snowball not the optimal solution? You pay the most in interest on the higher APR debts, the credit card balances. The “best” way, as defined by paying the least in interest, is to put extra money towards Credit Card A and Credit Card B, since they have 19.99% APR interest rates. Since you pay off the car loan first, according tot he debt snowball method, you are paying more in interest than you otherwise would have.

This afternoon, I’ll point out why this, less correct method, works better than the mathematically optimal one.

(Photo: shyald)

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17 Responses to “Dave Ramsey Debt Snowball Payoff Strategy”

  1. zapeta says:

    I think this works because its psychologically satisfying. You retire the smaller debt and you feel like you’re making progress. I guess we will find out this afternoon!

    • Glenn Lasher says:

      The psychological effect is exactly the point.

      Incidentally, I worked out what the difference would be for using the snowball order versus highest-interest-first for my particular pile of debt, and interestingly enough, the order of the debts wasn’t that different. Using the snowball would take 47 months; using the highest-interest-first took 46. The difference in cost also favoured the highest-interest-first approach, but was less than half of what I pay monthly in interest.

      As such, I adopted the snowball approach, because I can see things go away faster.

  2. Dylan says:

    Snowballing by size also helps protect you against financial emergencies because you reduce your total required minimum monthly payment oblations quickly. As debts are paid, you have one less monthly bill. This gives you more flexibility to handle an emergency out of your monthly cash flow, and if you are keeping a minimal emergency fund so you can put more money toward debt, that extra flexibility can help keep you from exhausting your emergency fund and adding more debt.

    I like to say, if you won’t have any financial emergencies, snowballing by interest rate will be the most efficient method. But if you do have any emergencies, snowballing another way might actually end up being more efficient.

  3. live green says:

    I was always under the impression that the mathematical method was more optimal because you are paying less interest on your money. I have never thought of it in terms of the psychology of the matter, but it makes complete sense. The less amount of loans you own, the better you feel and less burdened by the loans.

    The thing that makes this successful is to make sure to put your extra money towards the loans, especially when you start eliminating loans. One thing that I remember reading about his payoff strategy is to have an emergency fund so that you don’t continue to rely on debt. This will allow you to use your own money and not have to take out more debt when a situation comes up.

    • cdiver says:

      Correct. The mathmatical method works best if you can force yourself to be disciplined to see it through. Many people are not disciplined, explaining why some get into financial hardships.

  4. Vince says:

    I beleive the best strategy should be based on individual preference. You may save money paying off the highest interest rate loan first. However, if it takes you an extended period of time to obtain a zero balance you may lose interest and give up. If you have a small loan with low interest and you are able to pay it off in a few months that may motivate someone to pay off other loans. Personally, I put extra money towards the highest interest rate(5%)loan and try to extend the lowest(0%) for as long as possible. I can pay the 0% loans off today but, I look at it an investment with a return equal to inflation. It’s all about motivation, sticking to your plan and what makes you sleep best at night.

  5. Heisenberg says:

    Dave will often say, your method stinks and it’s what got you into this mess. Follow his method because it’s proven to work.

    While paying off your debt, you’re also changing your lifestyle. After 1 year, if you have 2 or 3 loans paid off, that’s a huge boost to keep with it rather than having 5 or 6 debts with just lower amounts after a year.

  6. Sun says:

    Wouldn’t consolidating your loans to a single loan have the same effect? Even getting a higher apr on the loan is psychologically advantageous? I understand the reasoning but there are some weak points to ramseys method? Why not balance transfer to a teaser low apr or even 0% like with Citi?

    • Scott says:

      I did this, but I personally think you are more likely to spend the “new-found cash flow” to buy more crap that got you into the original hole your climbing out of.

      If you are truly disciplined, it make sense. That would apply to 1-2% of the population, though…

  7. Michele says:

    Not everyone qualifies for those loans, especially if they have been a victim of balance chasing (bank lowers your credit limits to within $100 of your balances, and thus lowering your credit score by making you look maxed out when you weren’t the month before).

    I like the psychological aspect of this, however, in light of the new CC laws, something interesting I have noticed. When they publish the min payment (14-20 year payoff) vs the amount you need to pay to pay the balance in 3 years, sometimes that amount is $20 to $50 more than the min. I think if people new it would be that little to pay off the balance, they would have been paying that extra all along.

  8. Craig says:

    This is a bad idea all around. For starters, the minimum payment on most credit cards is $15. With $17,000 @ 19.99% his credit card debt will increase by over $250 per month.

    In addition, since credit cards are revolving credit their utilization rate effects your credit score. The “smart” decision would be to pay of the credit cards first, then start the Dave Ramsey plan.

    • Steph says:

      Minimum payments are calculated as an either-or. The minimum payment is EITHER that $15-$50/month stated in the contract OR interest PLUS some, whichever amount is larger. So, the minimum payment on the CCs would be ~$250 + an additional amount.

  9. Shirley says:

    I feel that whichever plan keeps you on track is the way to go. But with either one you have to have that emergency fund first. You simply have to plan for the unexpected even though it may never happen. Those expenses will derail any plan and set you back even more.

  10. kitty says:

    “Snowballing by size also helps protect you against financial emergencies because you reduce your total required minimum monthly payment oblations quickly”

    This is totally not true. Larger loans carry larger minimum balance. If you have one loan with a minimum payment of $15 and one large loan with minimum payment of $200, then eliminating the smaller loan will do next-to-nothing in reducing your minimum payment.

    Reduction in minimum payment would depend on loans, amounts and minimum payment required for each loans.

    BTW – to the blog author: There is something wrong with the spam filter here. A slightly different post than this one gave me “your post looks a bit spammy” message. There were no links or anything in my comment, it was pretty much the same as this one.

    • Steph says:

      While $200 > $15, the smaller debt balance can be paid off faster leaving less obligatory debt payment each month, which is what that comment was getting at. For example:

      Loan A = $1,500 @ 5% APR, $25 min
      Loan B = $30,000 @ 8% APR, $250 min
      CC = $15,000 @ 20% APR, $300 min
      Extra payment per month = $100

      Payoff Plan 1 (Balance Based):
      Loan A = 13 months
      CC = 62 months
      Loan B = 106 months
      Total Interest Payed = $25,450.15

      Payoff Plan 2 (APR Based):
      CC = 60 months
      Loan B = 70
      Loan A = 105 months
      Total Interest Payed = $24,379.60

      So, Plan 1 frees up $25 of obligatory payment after 13 months & another $300 after 62 months. However, Plan 2 doesn’t free up any obligatory payments until month 60. So, while Plan 2 is payed off one month sooner with just over $1,000 less in interest payments, Plan 1 frees up SOME payment obligations in about a year while you wouldn’t have some “relief” until year 6 with Plan 2.

  11. Scott says:

    In all honesty, I listened to Dave for 5-6 years. I was unknowingly using his principles and in 2004 we were debt free including the house in Dallas (making $80k in 1999 to $150k in 2004…)

    We are still “doing his plan”, just don’t get to listen to him as much. He was the cheerleader in our game and motivated me to keep going (wife eventually got on board in principle).

    6 years later, $900k in the bank…(sold the house and moved to Cali) We rent here as buying doesn’t make sense (yet) and save or earn in interest a total of $8-10k monthly at 40-46 in age. We do not work overtime, 5 days a week and do not work for union / government jobs, one in mfg. & one in insurance…

    If you stay focused and keep your priorities in view, anyone can succeed.

  12. Don says:

    I used the Snowball method and cleared some 10 or more accounts and all of my credit card debt in less than six months. Never underestimate the value of changing behavior and being rewarded for it. One year I was hand to mouth with no way to save due to monthly payments and expenses. Less than year later, after snowballing, I was debt free except for house and a few smaller student loans. I also had an emergency fund with several thousand dollars in it. The year that I lived hand to mouth was one of the most stressful of my life. NOTE: I did not have a significant salary increase if any during the year I eliminated my debt.


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