Tuesday, December 28, 2010

Snowball This!

As I review the various daily financial news items and personal finance blogs, I find myself ever more frequently running into a particular bit of financial advice that really drives me nuts. This is the concept of "snowballing" your debt. I think Dave Ramsey coined this back in 2009 and the term has been "snowballing" itself ever since. The idea behind this concept, as I understand it (and different financial gurus have different nuances to their particular plan), is that people will be more motivated to eliminate their debt if they can achieve small victories in their struggle toward financial independence. The plan calls for the debtor to pay off smaller debts first, working toward the larger debts last, regardless of which individual debt has the higher interest rate. This way you are always motivated to go after the next debt because you just had a success and now you have more funds (that you are not paying toward the now eliminated smaller debts) to apply to the next account.
Now I agree that success does breed motivation. But this "snowballing" idea is built in a sanitized dreamworld of people (apparently) having extra cash to apply to this project. Ramsey even says in his August 2009 article, "First accumulate $1,000 as an emergency fund." Heck, when I was in serious debt I couldn't have put together $100 for an emergency fund. Let's face it, if you are in serious debt trouble, you're not going to have an extra grand just lying around.
So, you might ask, what is your plan then Mr. Debt Guy?
Well, first let me say that I do agree that motivation is a big component in getting rid of your debt. Secondly, I do agree about paying off a credit (card) account for a small victory, but here is where I totally disagree with the "snowballing" concept (at least as originally proposed, because in my mind my plan "snowballs" too).
It is ridiculous to blindly pay off smaller debt accounts regardless of interest rate. Are you to pay off 5% accounts where you owe $2,000 each in lieu of a 30% account where you owe $10,000? Heck no!
That is, heck no, with one exception. I want you to pay off one small to medium sized credit card account first, preferably one where you are still in good standing. Now this will give you the "motivational victory" that the "snowballing" concept relies on, but it will also do another (and for me, more important) thing. It's going to give you an open credit account where your creditor may just want to extend you some additional credit. Believe me, if you have paid this account on time in the past, the creditor is going to want to make an offer to you to get you paying interest again. This will most likely come in the form of a reduced rate transfer offer. Now I am saying this from experience. As of this very moment I currently have two accounts that are at relatively low interest (4% and 8%), both of these were set up using this very same strategy. I paid off a card and in came the low rate offer; the 4% is permanent, and the 8% will roll up this summer (but I will pay it off by then). So this is what I want you to do.
Pay off that one card that you are in good standing with, and if there is another small balance where you can do the same thing, then great, do that one too. But then STOP! The rest of your funds need to go to paying off your high interest debts! If you pay only your low interest debts, how are you ever going to accumulate any capital paying those huge minimums on the high rate cards? So pay the high ones first!
Shortly, you should then receive a low interest balance transfer offer (or two). You then transfer your high rate balance (which hopefully you have reduced a little) to the low rate offer account.
Now, you have eliminated, or drastically reduced, that high rate account. Suddenly you have a lot more money to apply to the principle of your accounts, rather than just to that high interest you were paying.
Believe me, this works. It requires a little discipline, but it can work, for anybody.
What if you are too far in debt to attempt even this? Well then, the "snowball" plan would be even less of an alternative, and you would probably need to look at debt settlement (please try to avoid bankruptcy, see my earlier posts). If you attempt my plan but still need to go through debt settlement, you'll hopefully have a credit account or two that you paid off, and then may be able to keep through your settlement. This will help you get re-started on building your credit back up.
Please, try my plan.
Don't let those high interest rate cards continue to suck the financial life out of you. And if you have to go to settlement, it's not the end of the world. Get an attorney to help you, and you can be back on your feet in just a couple of years.


  1. So what's the difference between paying $2000 off the $10,000 card and paying off a $2000 card and then transfering the money?

  2. Thanks for your question. The difference is, you are going to get a lower rate on the smaller card. Instead of owing $2,000 at 15% (for example) and $8,000 at 30%, you will owe $2,000 at the new low rate (7% for example) and the other $8,000 at the same 30%. Every edge you can get is multiplied when you consider the impact of the interest year over year.