There have literally been entire books fluffed up just to teach what we’re about to show you. It’s the fastest and most effective way we’ve come across to eliminate debt when feasible (other than having it negotiated and wiped off). It genuinely can be a life changer, but most people have never heard of or considered it, regardless of how easy it is. This is also one of the only useful things Dave Ramsey or Suze Orman have ever taught their unfortunate followers*.
Part 1: Minimum Payments
Let’s start with somebody who has a fairly average amount of debt. Jim. The guy’s got 2 credit cards and worthless, yet crippling student debt.
1. Visa card has a $1,000 balance. Interest rate is 16%. Minimum payment is $25 a month.
2. Amazon card has a $4,700 balance. Interest rate is 25%. Min.payment is $150 a month.
3. Student debt balance is $37,000. Interest rate is 6%. Min. payment is $415 a month.
Ok, right off the bat. Notice that he’s paying $590 just to meet his minimum payments. His Amazon card’s interest is insane, but not unusual at all. It’s hard not to feel like you’re running on a financial treadmill when these are the kinds of debts you’re up against. Some ambitious, but misled people will sometimes add additional chunks of cash here and there to pay off the debts sooner when they get a tax return or something similar. They’ll spread out the extra payments to each one of the credit cards and wonder why they don’t seem to get ahead. There is no real system in place.
So if Jim decides to stay with this no system route and continues just making the minimum payments on each debt:
1. The Visa is paid off in 5 years. $480.59 paid in interest.
2. The Amazon card is paid off in 5 years, 2 months. $2,972.45 paid in interest.
3. His student debt will take almost 10 years (119 months). $11,906.68 paid in interest.
So it takes Jim just shy of 10 years to pay everything off (assuming he is able to keep his income at the same level) and he will have paid the credit card companies a total of $15,360 in interest. Depressing. As. Hell. But you already knew that…
Part 2: Rolling Payments
Here is where the trick begins…
Jim is going to make ONE small change. Whenever the first loan is paid off (the smallest debt balance), Jim will take the payment from the debt he just paid off and use it as an ADDITIONAL payment on the next biggest debt balance. So he pays off the Visa, then takes that $25 he was already paying and adds it to his Amazon payment for a total of $175 a month ($25 Visa + $150 Amazon). Remember, Jim isn’t having to work any harder to make ends meet. He was already paying this amount every month. The Amazon card gets paid off as well. He then takes the total Amazon payment of $175 and adds it to the $415 payment for student debt for a total of $590 a month. To recap, the only difference between the first example and this example is that Jim is rolling his debt payment over to add to the next debt payment instead of just using the money on other things. Let’s see if that changes any thing at all…
Open this link in another tab to follow along.
Put all of Jim’s debt into the calculator as seen below:
Click Go, scroll down and notice a few things:
The first thing you probably saw is the “saves you $0.00” and then another 0. At which point you probably thought “f*ck NSFW”. Understandable. Skip the words avalanche and snowball and check out the column that says Interest Paid. See how Interest Paid says $14,137 in both rows. Remember what what Jim ended up paying total before with minimum payments? $15,360.
Now look the column that says Payoff. 97 months. How long did it take before? 119 months.
Jim did not contribute ANY more than he was already going to pay and saved $1,223 and paid off the loan 21 months earlier. All from rolling one debt payment to the next.
Part 3: The Snowball or the Avalanche
Now, we’re going to see why you saw those sad ass $0.00’s in the calculator. When people talk about money makeovers or debt reduction plans, they’re obviously going to include something about budgeting to put a little bit of an extra payment towards your debt. You pay some amount on top of your minimum payments. Don’t get overwhelmed at the thought. You don’t have to pay much, it’s the strategy that makes this work.
Where you put that little extra bit you budgeted determines whether you’re going to be doing a debt snowball or a debt avalanche. In our example, Jim’s extra payment will be $50 a month (not because that should be your goal, but just because it’s a round number)
With a debt snowball (the system Dave Ramsey seems to think he invented) You order your debts from smallest balance to largest, and pay them off in that order, rolling each payment to the next. Jim’s order would go Visa ($1,000) Amazon ($4,700) Student Loans ($37,000) The additional $50 payment amount he makes will go to the smallest balance debt only, while he continues to make minimum payments on the other loans. He doesn’t split it 3 ways and pay extra on all 3 loans at once. So Jim pays an extra $50 on the Visa (the smallest balance. Making his monthly payment $75, because $50 + $25), and pays the minimum amounts on Amazon and the Student loans. When the Visa is paid off, the $75 adds to the $150 for the Amazon payment, and so on.
With a debt avalanche (Suze Orman’s preferred system) You order your debts from highest interest rate to lowest, and pay them off in that order, rolling each payment to the next. Jim would pay Amazon (26%) Visa (16%) then student debt (6%). Once again, the extra $50 will only be added to the first highest interest balance, not all 3 at once.
So to plug this into the calculator we’re using; all you need to do change the total monthly amount in Step 2 from $590 (all the min. payments added together) to $640 (min. payments + 50)
The results will look like this:
Now your reaction is probably “Jim only saved $248 f*ckn dollars!?” And the answer is “no, he saved way more”. He saves $248.54 more in interest payments by choosing the avalanche method over the snowball method in this case. But he will pay off his first debt (Visa) 18 months sooner by going with the snowball method (smallest balance first) instead of the avalanche (highest interest rate first)
Big picture, where did that $50 extra payment get Jim?
Ok, in the Payoff column it shows 86 months and 85 months and that the avalanche method allows him to pay everything off in 85 months. In the interest rate column, the avalanche method also pays less in interest, totaling $11,672.
This tells us that the avalanche method, pays everything off faster and saves more interest than the snowball method here. The only reason Jim might choose the snowball method is because he would pay off the first debt a year and a half quicker. He could go that route and be feel better eliminating one of his debts sooner, but would still end up paying more in interest and taking a month longer to pay everything off in the end.
So let’s go back to the numbers from part one for comparison.
Originally, Jim paid $15,360 over 119 months by making minimum payments.
By contributing an extra $50 a month and rolling his payments over depending on the next highest interest rate; Jim paid $11,672 over 85 months. (Debt Avalanche)
He’s debt free almost 3 years sooner and saved $3,688 in interest payments.
Part 4: That’s It…You’re done…
We didn’t pick the numbers for Jim’s situation out of a hat. His numbers are based on national averages for debts in 2018 and from people we’ve recently spoken to us about their debt issues.The “that’s just his one-off weird situation, that won’t work for me” argument isn’t going to fly here. You may see his numbers and say “well, it’s still going to take 7 years to pay everything off, why bother?” Unfortunately, that’s a common mindset. What typically happens is that several years down the road when the debt still looks the same people say “man, wish I started doing that a few years back.” Regardless, gather all your personal debt information and plug it into the calculator. Compare how much faster you can pay everything off by rolling payments and budgeting for extra payments. Review the numbers to see if you should go after the smallest balance first or attack the highest interest rate. Sometimes there is a much more clear picture on which to choose. The snowball method may pay everything off 2 years faster than the avalanche, for instance.
Another thing that may not have occurred to you… after all Jim’s debts are paid off he has an extra $590 that he didn’t have available before. That’s essentially a $7,080 raise he didn’t have to ask for. Think about how you could apply all the money you spend on debt payments for things you want without having to add more debt. If you’ve been wanting to go on a vacation, it doesn’t seem so hard to get the funds together when you were “already saving it”. You were just saving and giving it for the debt holders. If you’re planning for retirement, you might be able to max out a retirement account without even having to budget further. There is literally no downside to this method so you have nothing to lose by giving it a shot. And if you DO decide you don’t even want to bother, at least you didn’t have to wade through 300 pages of money guru garbage after paying $29.99+ just to make that decision.
Note: Unbury.us is an alternative calculator that some prefer for avalanche and snowball comparisons
*NEVER listen to their investment advice. Their personal finance and budgeting tips are typically fairly sound, but their investment advice is often completely misguided or just plain false. Perfect example is Dave Ramsey’s claim of the average mutual fund returning 12% a year. Horsesh*t. Tread with extreme caution with any of the following popular “money gurus”: Dave Ramsey, Suze Orman, Tony Robins, David Bach, Robert Kiyosaki. In future articles we will debunk claims from each one of them.