Debt can be a difficult for all of us. People are under ever-increasing cost of living pressures, and this means credit card limits get topped out, contracts get cancelled, and banks move people to the “high risk” category, meaning they’re not given access to any further credit.

A snowball is a simple enough visual – if you imagine a small snowball rolling down a mountain, it slowly accumulates more and more snow. By the time it reaches the bottom, it’s huge. This visual can be applied to debt too – however in this case it refers not to accumulating debt, but to getting out of debt. For many Australians, the “debt snowball” is an effective way to tackle the challenge of getting their finances back under control.

What does a debt snowball look like?

The basic principle of the debt snowball is that the borrower will focus on one specific debt at a time. Once it’s paid off, they’ll move on to the next one. The benefit to this system is that goals are met quickly, giving the individual a sense of personal satisfaction, and once a debt is repaid, it stops accumulating interest, making other debts even easier to repay.

Why it works

For people who can afford the minimum repayments on their bills, and have just a little extra to over-repay one debt at a time, the debt snowball is an incredibly easy plan to set up, that does not require any complicated formulas or the talents of an accountant. An individual with no special skill for numbers will be able to execute the debt snowball plan.

It’s an ideal plan for people who have large debts, because they will be able to see progress where they might have previously seen the debt as insurmountable.

How to set one up

To create your own debt snowball reduction plan, there’s a couple of simple steps that you should run through:

• Start by categorising the debts, in order of size. You’ll be targeting the smallest debt first, both to knock it off so you don’t feel overwhelmed by monthly bill statements, and to get it out of the way, allowing you to chip off larger chunks of the larger debts. This adds to a valuable psychological effect – you feel like you’re knocking debts down as you fly down the mountain, getting more and more powerful.
• Set aside enough money each month to pay off the precise minimum of each debt, except for the smallest debt. For that one pay off as much as you can afford. When that debt is gone, move on to the next one.
• Set aside $1,000 for emergencies. This fund is crucial, as it will give you a buffer to deal with unexpected expenses without having to add to the debt. Ideally you don’t want to take on any further debt as long as you’re adhering to a debt snowball plan.

An example of the debt snowball at work

Say you have three debts – $100, $200 and $500. In this hypothetical, for ease of reading, there are no interest rates, and the minimum repayments on each is $25. You have $100 per month to repay bills with.

For the first two months, you’re paying $50 on the $100 bill, and $25 on the other two. By the third month, you no longer have the $100 bill – now you only have two bills, and those debts are down to $150 and $450 respectively. It only takes another two months to pay the next bill off, as you have $75 to spend on it.

So, after four months, all that’s left is the large bill, with $400 remaining on it. This takes another four months to pay off, meaning you’re debt free in eight months.

Even once you factor in interest rates and the like, the debt snowball plan will get you out of bills far more quickly than spreading any additional money beyond the minimum repayments around.

Where the debt snowball is not ideal

If you’re in a situation where the minimum repayments on debts exceeds your capacity to repay them, then the debt snowball is going to be no help. In such circumstances, you’ll need to seek professional financial help.

Additionally, if you’ve got a massive bill well beyond half of your total income, such as a mortgage, then the debt snowball isn’t the ideal way to look at paying it off. The debt snowball is more designed to target multiple smaller bills that take up a small percentage of an individual’s income.