Hi guys! This week, I wanted to talk more about a practical application of paying off debt. Last week, we touched on the avalanche and the snowball methods of paying off debt early. The avalanche method focus on paying off the debt with the highest interest rate first. The snowball method focuses on paying off the debt with the lowest balance first. Using the monthly net pay of $2,500 that we started with last week, let’s take a detailed look at the snowball method.
Let’s lay the foundation by refreshing you on the budget that we established last week:
| CATEGORY | AMOUNT | PERCENTAGE |
| Tithe | $250 | 10% |
| Recurring Bills | $1,250 | 50% |
| Savings | $250 | 10% |
| Spending | $750 | 30% |
Remember that this is just a guideline to get you started on an easy way to customize your own budget. Plug in your monthly income and go from there. For this week’s example, we’re going to assume the following:
- Monthly income: $2,500
- Tithe: 10% or $250 per month
- Recurring Bills: 50% or $1,250 per month
- Recurring debt payments included here:
- Credit Card #1: $25 per month minimum payment toward $825 remaining balance
- Credit Card #2: $55 per month minimum payment toward $1,485 remaining balance
- Student Loan: $125 per month minimum payment toward $6,335 remaining balance
- Recurring debt payments included here:
- Spending: 30% or $750 per month
- Rainy day fund of $1,000 has been saved
For the purpose of illustrating how this is going to work, I’m going to ignore interest and focus on the principal balance, but keep in mind that interest is accumulating and being charged to you every month for as long as you’re carrying a balance.
Now, since the rainy day fund has already been saved – met the $1,000 savings goal – we’re going to redirect that $250 per month savings budget toward paying the debt off early. Credit card #1 has the lowest balance, so we’re going to take the regular minimum monthly payment of $25 and add the $250 to that. Continue sending the minimum monthly payment to credit card #2 and the student loan.
| MONTH | BEGINNING BALANCE | MINUS AMOUNT OF PAYMENT SENT | REMAINING BALANCE |
| APRIL 2021 | $825 | $275 | $550 |
| MAY 2021 | $550 | $275 | $275 |
| JUNE 2021 | $275 | $275 | $0 |
Credit card #1 is paid off in 3 months! We’ll celebrate by taking that $275 and adding it to the $55 minimum payment we’ve been sending to credit card #2 and continue sending the minimum payment to the student loan. The balance for credit card #2 is down $165 since we were still sending the minimum payment while we were aggressively paying down credit card #1. The balance of credit card #2 is now $1,320.
| MONTH | BEGINNING BALANCE | MINUS AMOUNT OF PAYMENT SENT | REMAINING BALANCE |
| JULY 2021 | $1,320 | $330 | $990 |
| AUGUST 2021 | $990 | $330 | $660 |
| SEPTEMBER 2021 | $660 | $330 | $330 |
| OCTOBER 2021 | $330 | $330 | $0 |
After 4 more months, credit card #2 is paid off. By now, you know what to do! We’re going to take this $330 from paying off both credit cards and add it to the $125 minimum payment we’ve been making to the student loan and start sending $455 per month until the loan is paid off. The balance of the loan is down $875 since we continued to make the minimum payment while paying off both credit cards. The balance now is $5,460
| MONTH | BEGINNING BALANCE | MINUS AMOUNT OF PAYMENT SENT | REMAINING BALANCE |
| NOVEMBER 2021 | $5,460 | $455 | $5,005 |
| DECEMBER 2021 | $5,005 | $455 | $4,550 |
| JANUARY 2022 | $4,550 | $455 | $4,095 |
| FEBRUARY 2022 | $4,095 | $455 | $3,640 |
| MARCH 2022 | $3,640 | $455 | $3,185 |
| APRIL 2022 | $3,185 | $455 | $2,730 |
| MAY 2022 | $2,730 | $455 | $2,275 |
| JUNE 2022 | $2,275 | $455 | $1,820 |
| JULY 2022 | $1,820 | $455 | $1,365 |
| AUGUST 2022 | $1,365 | $455 | $910 |
| SEPTEMBER 2022 | $910 | $455 | $455 |
| OCTOBER 2022 | $455 | $455 | $0 |
After one year, the $5,460 student loan balance is paid off.
If you’re like me, having a visual representation like this is really motivating. This is the same approach that I took when paying off my student loans and credit card debt. I knew upfront exactly how much I should be able to set aside and when and kept pressing toward my target payoff dates. The rainy day money that I’d set aside was also a nice peace of mind. I knew that if something came up, I’d be able to take care of it without putting myself further in debt and stay focused on paying everything off.
So, what would’ve happened if we kept making the minimum monthly payments? Again, for illustration purposes, I’m not going to factor in interest, but unless you have zero-interest debt (if you do, verify the payoff terms), know that interest is going to be charged to you every month for as long as you have a balance and will affect how long it takes you to pay off your debt. The good news though is that interest is calculated based on your remaining principal balance. The more you pay toward principal every month, the smaller your rolling remaining balance is and the less interest you’ll have to pay out over time. So, looking at this as zero-interest debt, here’s a side-by-side comparison of how long it took to pay it off using the snowball method vs how long it would have taken if we continued to only send the minimum monthly payments:
| DEBT | TIME TO PAYOFF VIA THE SNOWBALL METHOD | TIME TO PAYOFF VIA MINIMUM MONTHLY PAYMENTS |
| CREDIT CARD #1 | Paying $275 per month, $825 paid off in 3 months | Paying $25 per month, $825 paid off in 33 months |
| CREDIT CARD #2 | Pay $55 per month for 3 months while paying off card #1, $1,485 balance now down to $1,320 Then paying $330 per month, $1,320 paid off in 4 months 7 months total | Paying $55 per month, $1,485 paid off in 27 months |
| STUDENT LOAN | Pay $125 per month for 7 months while paying off both cards, $6,335 balance now down to $5,460 Then paying $455 per month, $5,460 paid off in 12 months 19 months total | Paying $125 per month, $6,335 paid off in 50.7 months or 51 months |
Aggressively paying down this debt via the snowball method meant that we’ve become debt-free in 1 year and 7 months instead of the 4 years and 3 months it would have taken by only sending the minimum monthly payment. This is huge! It also positively affects certain things like net worth and debt-to-income ratio much faster (more on that in a future post). With debt paid off, you can save faster toward your other goals like building your emergency fund, buying a home, buying a car, taking a dream vacation, starting a college fund for your children, or whatever that goal looks like for you and your family (though my strong recommendation is to fully fund your emergency fund next). More than that, you can truly begin building wealth long term. Instead of putting money toward paying off debt, those same dollars could be your retirement savings or mutual fund investments. The point is that your money is now YOUR MONEY – not the credit card company’s, not the loan’s, YOURS.
Take a few minutes to sit down and plug in your debt and current monthly payments and see if the snowball method could work for you. Or use the avalanche method if that is your preference. Again, the difference is how you line up your debt and decide which one to pay first. The avalanche method is focusing on putting extra money toward the principal balance of the debt with the highest interest rate first while continuing to pay the minimum monthly payment on your other debt. After the first debt is paid off, take the money you were sending toward it, add it to the minimum amount that you’re sending to the next debt in line, pay that one off and keep going until all of your debt is gone.
The process to getting to debt freedom is simpler than you think. There’s been such a mystery around it that a lot of people get discouraged, but I want to be as detailed as I can to let you know that it’s possible and the plan does not have to be complicated. Let me know in the comments if this breakdown was helpful for you!
Jan's Life 