Snowballing.

There are many ways to reduce debt. Often however, once a person's credit rating has been affected, many options are ruled out. This is the point at which people opt for the worst possible form of lending: a loan secured on their property.

This can be avoided and debt can be tackled using the debt elimination method of snowballing.

What is snowballing?

It is a way of prioritising debts and then paying them off in order of that priority. Instead of juggling payments on store and credit cards for example, one card is targeted as the priority debt, minimum payments are made on the other cards, and all available funds are paid off the priority card. This continues monthly until the priority card is paid in full.

Then the second highest priority card is targeted and the process is repeated. Each time a card debt is cleared, it leaves more funds available to target the next card with. This is the "snowball effect". As time goes on the debts reduce quicker; the momentum building like a snowball rolling down a hill.

How are debts prioritised?

There are two methods:

1. The APR method.
   
   With this method, debts are prioritised according to their rate of interest: the higher the interest, the higher its priority. Mathematically, this is the quickest method of debt elimination; however, if the highest interest borrowing is also the largest, it can take a long time before the first debt is cleared so it's a long time before the benefit of the system is perceived.
   
   
2. The outstanding balance method.
   
   This method prioritises debts according to how quickly they can be cleared: the smaller the outstanding balance, the higher its priority. The advantage of this method is that smaller debts will quickly be eliminated and this shows that the method is working: which can be a psychological boost to staying motivated.
   
   

In practice, both methods perform similarly. With a lot of small cards and balances, the outstanding balance method may prove to be more convenient; however, the APR method always works out as the quickest and cheapest method in the long run.

How quickly does it work?

That really depends on the level of debt, the level of interest, and on how much money can be put into the plan. The more money available the quicker that debt will be eliminated. Most advocates of the snowball method encourage people to try and save 5-10% of household expenditure and apply that saving to the debt elimination plan. Money can be saved by making many simple changes, most of which are explained on Martin Lewis's excellent website www.moneysavingexpert.com (opens in a new window).

Example.

Someone has three credit cards and £500 a month with which to pay them off (£400 in minimum payments + £100 expenditure saved).

By paying minimum payments on cards 1 and 3 and targeting card 2 as the priority card, Card 2 will be paid off in 2 years. The next card targeted is Card 3. It now gets its minimum payment plus all the money that was targeting Card 2. Card 3 will be paid off in full after another 18 months. This leaves Card 1 which now gets everything thrown at it. It will be paid off in full in another 12 months.

The £20,000 debt has been cleared in 4½ years with an interest load of £6,687.00 (see: snowball calculator - opens in a new window).

Are there better alternatives?

When dealing with high interest debt, it is often cheaper to use a consolidation loan at a lower APR to clear the balances. This will be cheaper as long as the loan is for the same amount over the same time period. e.g. a £20,000 loan @ 9.9% APR over 5 years has a monthly repayment of £423.96 and an interest load of £5,437.45.

£20,000 over 4 years @ 9.9% APR has a monthly payment of £506.29 and an interest load of £4,302.00.

Also swapping to credit cards which have a 0% introductory offer will eliminate interest payments, for a while at least.

The ability to get new cards and loans at a reasonable rate is dependent on a good credit history however.

Conclusion.

Snowballing is a very useful method of debt elimination. It can't be applied to everything, fixed rate loans for example, but where there's payment flexibility it really does work.

It is most useful where alternatives, such as lower rate personal loans or card switching, are not an option due to poor credit rating, for example.

Many people consider a loan secured on their property when other options run out; however, with discipline and determination, snowballing debts is a viable, much cheaper in the long run, and far less risky, alternative.