Get Debt Free with the Snowball Method
Many Australians are finding it difficult to become free of their debts. As a nation, we boast one of the highest debt-to-income ratios in the world and we’re plunging further into debt. In fact, Gateway Bank’s data revealed that in the past 12 months, 28 per cent of its consumer loan applications were made for the purpose of debt consolidation or refinancing.
With wage growth increasing at a healthy rate of 2.1 per cent year-on-year, why is it then that we’re unable to achieve financial freedom?
The issue is rooted in our approach to debt.
Australians see our debts as a chore, and many of us procrastinate when trying to tackle it down. For a majority, paying off our financial liabilities is the last thing on our list of priorities and, as a result, we continue to accrue interest on our debts, making it exceedingly difficult to break free of them.
However, when armed with the right strategy, it’s easier than you’d think to tackle multiple debts at once. Here, we take a look at the tried-and-tested ‘snowball technique’. This particular technique takes advantage of the motivation you gain from the momentum of paying smaller debts off quickly.
Step 1. Take stock of all your debts
Unlike other debt reduction strategies, the snowball method focuses on your balance, rather than the interest rates. The first step is to list out all your debts in order of balance, from smallest to largest.
If two or more of your debts have very similar balances, place the highest interest rate debt to the front. Otherwise, the list should remain in ascending order.
Step 2. Budget
The success of the snowball method relies on budgeting. Whilst it can be daunting, it’s simple to create a budget which takes into account your recurring expenses, debt repayments – whether that’s monthly, fortnightly or weekly – discretionary spending and savings.
Once you have a clear picture of your finances, consider creating three separate bank accounts; your savings, your expenses and your spending. Separating your money in this way will make it easier to stick to your budget.
Step 3. Aggressively tackle down the smallest debt
This is where you begin your journey to financial freedom. Once you have a budget in place, the focus is to throw as much money into getting rid of your smallest debt first, whilst continuing to make the minimum repayments on the rest of your debts.
After assessing your budget, carefully think about your savings and discretionary spending and try to redirect a small percentage of your discretionary spending and savings into your debt repayments. Funnelling a little bit of extra funds into your smallest debt each month will help you to eliminate the debt as quickly as possible.
It’s important to continue providing yourself with a set amount to enjoy on lifestyle choices and entertainment, as well as savings. Psychologically, it’s beneficial for your financial health to see your wealth grow – even if incrementally. At the same time, continuing to “treat yourself” is great for motivation. However, during your debt reduction period, remember it’s key to make paying down your debts a priority.
Step 4. Plough through the rest
Once you’ve cleared off your smallest debt, it’s time to continue the snowball effect by moving onto your next one. The principle remains the same. You set aside a portion of your income to recurring expenses, savings, discretionary spending and tackle the next debt with as much vigour as possible. Follow this cycle until you reach financial freedom.
Getting rid of debt is more about shifting your mindset than it is about being equipped with endless amounts of financial knowledge. To remain motivated, most of us will need quick wins to keep us on the right track and the psychological benefits of seeing rapid results through the snowball method will encourage you to continue paying off your debts. Once you’ve reached your goal of financial freedom, you can start setting aside a little more for yourself and into your savings to grow your wealth.