The Debt Snowball Plan

I was reading through some older posts on my favorite personal finance blog, The Simple Dollar, and I saw a post related to a snowball debt reduction plan I’ve been wanting to employ myself. Trent calls it the “Scared Straight” snowball.

The “Scared Straight” Snowball Debt Reduction Plan

Basically, the plan is to make minimum payments on all your debt and pile your remaining get-out-of-debt money into a high-yielding savings account such as the one offered by Smarty Pig. When the balance in that savings account exceeds the balance of your smallest debt by 30%, the snowball plan calls for you to transfer the money into checking and eliminate that smallest debt.

As Trent points out this is probably not the smartest (mathematically) way to approach the debt snowball, but for those of us with somewhat shaky jobs, or in one-income families, it makes for a better night’s sleep to have a few thousand in savings at any given time. I’d gladly give up a couple months worth of interest to have a pile of money in the bank at the ready.

I may make one slight variation to his plan and preserve a $1,000 savings threshold – so when my savings balance equals my smallest debt, plus $1,000, I will bring the savings balance down to $1,000 and pay off the debt. Another idea to consider if you have several smaller debts (like I did in the beginning) would be to group those debts together to make one larger debt.

For instance, I had three debts under $500. If I was using the “Scared Straight” plan back then I would have grouped them into one $1,300 debt and used that as my target savings amount, otherwise you’ll be making several transfers out of your high-yield savings account to pay down the debt snowball, and it could cause a fee to be assessed on your savings account.

The Original Debt Snowball Plan

The original debt snowball plan was made popular by Dave Ramsey in one of my favorite personal finance books and New York Times bestseller, The Total Money Makeover. If you haven’t read the book, I highly recommend it (here’s a link to my review of The Total Money Makeover).

Comments

  1. I think its a great idea. I’m not seriously in debt (yet, haha, those student loans are starting to stack up), but my credit to balance ratio isn’t looking so good. Anytime I found myself with an extra hundred bucks or so after I put it in my cruise fund, I put it into my credit card. But my mindset then was that “Oh, I just put in $200 on this card, its okay to spend $100 of it.” So it was more like 2 steps forwards and one step back. I plan on adopting the modified version (the pay-off buffer) of the Scared Straight. Thanks for the tip.

  2. We’ve started doing this with our mortgage prepayment money. The thought of locking our monthly surplus in equity is a bit scary right now – no chance of getting a HELOC, ect.

    We’re compromising by putting our prepayment money, $300-500 each month, in a 12-month ING CD at 4.5%. It’s not a 6.5% mortgage paydown, but I like having that cash around right now. We’ll see how our jobs and the credit market look in 12 months…

    As a side note, we also have a 6-month emergency fund. I’m probably overreacting. But that extra cash sure makes me sleep better at night!

  3. I don’t know if this method would work for me. I am a person that goes to the checking/savings account a little more than I should. The only way I’ve saved money is by increasing my 401k plan, changing the amount of taxes to come out of my check each year (so I get more back at tax time) and putting money into my roth as soon as I get paid. (I can withdraw without penalty but there’s more hoops to jump through to get it. So far, I kind of forget it’s there-which is good) I do a kind of snowball effect where I use all my extra money to pay down the smallest credit card/loan first and then I take that old payment with the extra money and go to the next smallest one. I pay it right at payday because the faster it’s out of my grimey hands the better. I hear all the time that you save more money if you pay off your highest interest debt, but I’m a results kinda gal. When I see change happen quicker I’m more proud of myself and more willing to stick with something than to give it up. I do use your envelope system. It works wonders and keeps me in line. I also hide my credit cards at home and put my checkcard in a sealed envelope marked “just for gas”. It slows down my impulse urge to buy something I don’t have cash for so I can think whether I should get it or not. I’ve also found that keeping reciepts or writing on the envelope what I’ve bought helps me reflect on where all the money is going and where my problem areas are (ex: bottled water/soda at gas stations). I may sound pathetic, but hey, ya gotta do what works for you!

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