Whatever you want to call it… it works! If you seriously want to pay off debt fast, building up a better credit score, and starting a brighter financial future, here’s what you need to do:
Step 1: Gather all your most recent bills from your credit cards, car loans, student loans, and anything else you are paying interest and finance charges on and want to pay off.
The best way to do this is grab them as soon as they come in the mail and put them in a brightly colored envelope you clip to your fridge with a big magnet.
Step 2: Make a list of all your debts in order of how much you owe, lowest first.
Once your stack is complete, write down the name of each creditor, the balance you owe, the minimum payment, and the interest rate. You will start by attacking the bill with the lowest balance first with all you’ve got to throw at it. We like to recommend you start with the smallest balance first because paying that first bill off is a BIG emotional boost. You can use that energy to help power you through when times get tough.
(If you are more worried about the total interest you’ll pay, you can start with the highest interest rate first. It may take a little longer to get to that first happy-pay-off moment, but you will pay less in interest in the long run.)
Step 3: Figure out how much extra you can contribute to the minimum payment on the first bill on your list. This is your “accelerator”.
If all you do is continue to make minimum payments on all your debts, you’ll be drowning in your debt for the rest of your life. To pay it off… you have to make a sacrifice to get the “snowball” rolling. Examine your budget and daily spending habits. If you can just scrape $20 or $50 extra a month, it will help… a lot!
Step 4: Continue making minimum payments on all your other debts and add your accelerator to the first debt on your list until it is paid off.
To see just how powerful this method of debt payoff is, check out this customizable tool from Financial Mentor.
It is very important that you continue to make all your payments on time. Make a commitment to never have a late fee assessed against you ever again!
Once that first debt is gone, celebrate a little. You’ve accomplished something great!
Step 5: Start working on debt #2!
Now, here’s where the debt “snowball” gets its name. You know how you can take a small snowball and roll it down a hill to make it get bigger and bigger? Well, that’s what you are doing with your payments now.
You take the entire amount (minimum + accelerator) that you were paying to your first debt and ADD it to the minimum payment for the second debt.
For example, if the minimum payment on your first debt was $45 and you added a $25 accelerator to it, you were paying $70 a month. Now that bill is paid off so that $70 is your new accelerator. You add the whole amount to the minimum of debt #2 to pay it off faster.
Step 6: Keep it going until the debt is gone!
With each debt you pay off, your accelerator will get bigger. By the time you are on your 6th debt, your accelerator will be the total of the first 5 minimum payments plus your original accelerator!
And when the last debt is paid off, you’ll have a fat chunk of money you can invest each month for your retirement, your kids’ education, start a business, or whatever your heart desires.
So what does all this have to do with credit scores? A couple of things, actually.
You’ll be paying your balances down which improves your Utilization Ratio. This will raise your score. And as your total debt goes down, your debt-to-income ratio improves, making it easier for you to qualify for prime financing when you need it to buy a home.
Just remember to keep those paid-off accounts open! Keeping accounts with a zero balance active with a small purchase every few months will improve your credit score, too. But closing them lowers your total available credit, which increases your utilization ratio and it makes you look like bad credit risk to lenders.