Imagine if you will, you’re standing at the top of a snow-covered hill; you scoop some snow, shape it into a ball and then send it rolling down the hill. As the snowball gathers speed, it picks up more snow, getting bigger and bigger until eventually it crashes into an obstacle and explodes.
The above is a practical example of what is known as the snowball effect and is true of both getting into debt and getting out of debt. Once you are in debt, it may seem easy to get more credit to pay off your first credit agreement, but this only puts you deeper in your creditors’ pockets and the ‘crash’ at the end could spell disaster for you and your family.
Rather put the snowball effect to good use and start your journey in becoming debt-free; all it takes is a little bit of planning and a lot of dedication.
The snowball effect requires that you make a list of all your debts, from the smallest amount owed to the biggest, excluding your bond and don’t work on the interest, just on the amount owed. Now work out how much extra you can pay towards the lowest debt, while continuing to pay the minimum amount on your other debts.
Pay this extra amount towards the smallest debt until it’s paid off. Then take the whole amount that you were paying on the first debt, and add it to your second lowest debt. Once this is paid off, take the entire amount of the second debt and pay it towards the third debt – continue until all your debts are paid off.
Here is an example of the snowball effect in action:
Joe has the following accounts:
- Retail account R5 000 owed, minimum repayment is R250
- Credit card R5 000 owed, minimum payment R200
- Revolving loan R20 000 owed, minimum payment R500
- Car payment R80 000 owed, minimum payment R1 500
And he has an additional R500 available monthly to offset against his debt.
He starts by adding the R500 to his retail account, and pays this off within 7 months. He then takes the full R750 and adds it to the minimum amount he is paying on his credit card; this is now R950 allowing him to pay his credit card off within 10 months. He adds the R950 to the minimum on his revolving loan and pays it off within 2 years and settles his car within 3 years.
In theory, by the time Joe’s final debts are reached, the extra amount he will be paying will see him paying off years of debt in a matter of months, not only saving him money on interest, but also allowing him to enjoy a debt-free life that much sooner.
Once all his debts have been settled, Joe has almost R3 000 that he can use in various ways. Obviously the best option for Joe is to take advantage of compound interest and save this money, or at least half of it every month so that he doesn’t have to rely on credit (accounts or cards) for any small to medium purchases going forward.
American financial author, Dave Ramsey, known for his support of the snowball method, states that personal finance is “20 percent head knowledge and 80 percent behaviour” and that people trying to reduce debt need “quick wins”, such as fewer accounts from creditors, in order to remain motivated toward debt reduction.
Ramsey adds that “you must gain control over your money or the lack of it will forever control you.” By using the snowball method, you can actively control your finances and see a positive result that much more quickly.
Once you have cleared your debt, then you need to relook at your budget to see where you can positively use your money for your long-term benefit in order to prevent getting into the debt trap again. The next time you want to purchase something other than a car or house on credit, remember the words of Nathan Morris: “Every time you borrow money, you’re robbing your future self.”