The Debt Snowball Explained:
Baby Step 2 - The Debt Snowball is basically paying off the smallest debt and then applying that payment amount to the next smallest debt. Once the the second debt is paid off, you apply the payment from the first and the second debt to the third in line and so on, thus creating a snowball effect.
In his book The Total Money Makeover, Dave Ramsey says, "...That personal finance is 80 percent behavior and 20 percent head knowledge. The Debt Snowball is designed the way it is because we are more concerned with modifying behavior than correct mathematics."
He asks that you list your debts from the smallest balance to the largest balance and work on paying that smallest one off first in an attempt to change your habits and your behavior. The theory behind it is that if you start to see success by paying off the smaller loans in a faster manner, you will be motivated to continue with the program. If you have two debts that are about the same amount, you will then list the one with the highest interest rate first, but in all other circumstance, you list your debts from smallest balance to largest.
Example listed in Financial Peace Revisited:
Sue and Joe's Monthly Debt Payments
Item Balance Payment Interest Rate
Gas Card $400 $60 18%
MasterCard $700 $70 18%
Visa $1,200 $200 18%
Car $6,500 $250 12%
Student Loan $7,000 $123 9%
House $60,000 $540 9%
"Joe decides to work some overtime or Sue has a garage sale and you pay off the gas card in the first month. Next, do not spend the $60 per month you used to spend on the gas card; instead add $60 to the next payment on the list. You are then paying MasterCard $130 per month until paid. That will pay off in the seventh month. Then you add $130 to the $200 Visa payment so that you are paying $330. Because you have already been paying on Visa for seven months, it will pay off in the eighth month (the next month). So you add $330 to your car payment of $250, making your car payment $580. That will cause the car to be paid off in seventeen more months, only twenty-five months into our program. The happy ending of your story is that everything in our example (and yours will vary) is paid off in thirty-two months except the house."
