The debt snowball is one of the most well-known methods of getting out of debt, and it’s also made popular by that financial guy on the radio, Dave Ramsey.
But, here’s the thing: Whether or not you like Dave Ramsey, his debt snowball method has helped thousands of people become debt-free. Financial freedom is a powerful motivator.
That’s not all. The debt snowball works not just because of the money involved, but because it’s a mind game. And, I firmly believe that life is nothing more than a mind game. One big game that, if your mind is in the right place, amazing things can (and will) happen.
And they won’t “just happen”, either. You will make them happen.
I am a perfect example. Though I was never buried underneath a pile of debt, I did spend good money on stupid things and made virtually every mistake in the book.
- I bought a Corvette that turned into a money pit
- I routinely cheated my budget with every paycheck, and
- Never saved more than the minimum at work (until the end!)
Paying off debt is very often the first step toward financial freedom. The mistakes we make also make us stronger people, but only if we learn from them.
Today, I have the guy behind the Semi-Retire Plan blog in the house to explain the debt snowball and why our brains scientifically like these types of debt payoff plans.
Your mind is going to like this.
First, why pay off debt early?
It’s no secret that debt is a big problem all over the world. And, the United States is no exception. Here, try to wrap that brain of yours around this disheartening statistic:
“Consumer Debt Reaches $13 Trillion in Q4 2018”
That’s according to Experian.
“Americans’ credit spending was greater than ever in 2018, as debt levels reached record totals,” wrote Experian. Here are some numbers across broad categories:
- Credit card debt reached an all-time high of $834 billion.
- Mortgage debt reached a new high of $9.4 trillion.
- Personal loan debt totaled $291 billion and was the fastest-growing type of consumer debt in the past year.
- Student loan debt reached a record high of $1.37 trillion.
- Auto loan balances hit $1.27 trillion, an all-time high, coupled with a new record for the average monthly auto payment, at $523.
Shesh! And, this affects people of all ages (and sizes!):
There’s no question that paying off debt needs to be a priority. Aggressively getting out of debt early has several advantages.
- Reduce your total amount of interest paid over the life of the loan by effectively shortening the loan term
- Have extra cash leftover each paycheck after you finish paying off each loan
- Increase your net worth with certainty – without the volatility that accompanies more traditional investments
How debt freedom works
First, I recommend evaluating what caused your debt. If you have high-interest consumer debt, what steps will you take to avoid incurring additional indebtedness in the future?
For example, if you don’t already have an emergency fund, I encourage you to build one. Paying an unexpected expense out of pocket isn’t fun, but it’s better than adding 25% in annual interest from using a credit card.
Is your debt from medical expenses? Make sure you have the best health insurance for your family’s situation in the future. Are you making the most of the options available from the Affordable Care Act?
You may also be able to gain tax advantages and avoid medical debt in retirement by using a Health Savings Account.
Or in some cases, your income may just be too low to get traction on the road to financial independence. If so, you may want to consider a job change, even if it’s early in your career.
Another thing to avoid during times of higher debt loads is lifestyle creep.
That happens when you get a little extra income and spend it on things you’ve wanted but probably don’t need. The cost of these items is often not one time things. They stay in the budget for some time to come.
Debt snowball: How it works
Using this method, order your debts from smallest to largest. The idea is to give yourself achievements along the way to becoming debt free by focusing on smaller and more easily-manageable debts first, then progress upward to larger debt.
This is in contrast to focusing on the biggest debt with the highest interest first, which can seem like a long, long way off. Most of us need a brighter light at the end of a shorter tunnel!
You can exclude the mortgage on your primary residence. Every month, pay the minimum payment on each debt plus an additional payment on the one with the smallest balance. Once the smallest debt is paid off, you pay extra on the next lowest.
Repeat until you’re debt-free, then stay out of debt!
In this debt payment plan, the type of debt is not relevant. For example, the snowball system does not consider if the debt is a car payment, a mortgage on a second home, or an unsecured debt (which typically have higher interest rates).
The advantage of using this debt strategy is that you’ll reduce your monthly payments (each time you pay off a debt) and you’ll save money on future monthly interest by not paying for the full term of your loans.
Then, you can use your extra money each month to invest or even pay off your mortgage!
Problems with the debt snowball method
The controversial element to this is that the debt snowball does not consider the interest rates of the debts during prioritization. Mathematically, you would benefit most by paying off your highest interest debts first. There’s a name for this approach – the “debt avalanche.”
Furthermore, should you try to pay off your debts early if they have a low-interest rate?
In theory, you might be better off investing your money than paying extra towards the debt at a low rate. Why would you accept a 4% “return” from paying off your student loan early (and avoiding future interest), when you could make 7-10% invested in index funds?
More traditional debt management techniques include transferring your balance to a home equity loan or debt consolidation loan to shift to lower interest rates quickly.
Ultimately, the approach that is right for you is mainly dependent on your own goals and risk tolerance. Notably, though, people using the debt snowball method have a reputation for being ultra-focused and passionate about their progress. Why? What makes paying off small debts more exciting than paying off debts that are costing you more in interest?
In other words, because of chemicals in the brain and gut!
And although debt repayment brought us to this topic, there are practical applications for you below, no matter what financial stage you’re in.
Debt and the brain: Dopamine
Neurotransmitters are chemicals that transmit between neurons or nerve cells. Dopamine, the “feel good” neurotransmitter, helps us focus and makes us feel happy when we meet our goals.
The debt snowball method is structured to help you achieve wins as quickly as possible since you’re making additional payments on your smallest debts first.
By completing the initial goals rapidly, you are getting dopamine spikes more often. This makes you feel good, which makes you want to repeat the behavior.
It also keeps you focused on your plan. Small victories matter.
Visually tracking your debt journey, for example, can help you realize your progress and feel gratification. You can essentially “gamify” your finances to increase your happiness.
Dr. Nora D. Volkow, the Director of the National Institute on Drug Abuse at the National Institutes of Health, shared a powerful visual about the power of dopamine. “[Mice can] die of starvation because they don’t have the motivation to engage in the behaviors to go and eat the food. You can rescue this animal by injecting dopamine into the areas of the brain that control this. But if you don’t do that, these animals will die of starvation. And that really epitomizes how extraordinary important dopamine is. It gives you that energy, the drive to do things.”
Dopamine gives you the drive to do things!
Debt and the brain: Endorphins
When you are exercising, stressed, or excited, endorphins are released by the pituitary glands and the hypothalamus. They produce a feeling of relief and being pain-free.
In addition to killing pain, endorphins can act as antidepressants, sleep enhancers, and even as self-esteem boosters.
Debt is stressful. But by facing it head-on and pushing yourself to spend less and pay more against your debts, you will experience emotional pain relief from endorphins. A little extra sleep and self-esteem can always help too, right?
Debt and the brain: Oxytocin
Oxytocin spikes during emotional moments, and it makes you feel high. It’s primarily associated with moments of feeling unity and trust, and it strengthens personal connections.
When people are paying off debt with intensity, it feels like they’re a part of a movement that is greater than themselves. They’re a part of a community, all pursuing freedom.
Dave Ramsey, who popularized the debt snowball, invites listeners to do a “debt-free scream” on the radio show each day — these are clear high moments after stressful fights for financial freedom.
Even if you choose a different debt repayment approach or if you’re already debt-free, there are several takeaways you can use in your own life.
Train your brain to tackle debt
Russian physiologist Ivan Pavlov, whose studies are now synonymous with his name, researched appetite, and involuntary responses. His famous work with dogs actually shows how our behavior changes when we start to achieve our goals.
In Pavlov’s study, he rang a bell or played the metronome while dogs were eating. After repeating these conditions, the dogs eventually would salivate at the sound of the bell even if the food was not present.
This is called classical conditioning.
When you achieve your goals, neurotransmitters help you feel good. If you do this frequently, you will condition yourself to feel good about goals. This will make you even more motivated for your next pursuit.
Unlike the dogs, though, you can choose to ring your own “bell” in life! Here are the 3 ways you can proactively set yourself up for success.
Debt snowball: Practical takeaways
Set small and achievable goals
The debt snowball benefits from having pre-set small goals in place. Each debt you pay off is a goal you are achieving. But, if debt freedom isn’t your current focus, then identify what’s most important to you in life. Next, break your long-term financial goals into concrete, smaller steps.
You may already be familiar with SMART goals. This acronym is popular in corporate settings and stands for Specific, Measurable, Achievable, Realistic, and Time-bound. Well, I would add on “And Fast” – you need to set goals that you can reach in a brief period to maximize the gratification benefit.
For example, rather than phrasing your goal as “I want to retire early in 10 years,” make a smaller goal of “invest $1,000 this month” or “make $100 this week from my side hustle.”
Honestly, even these goals can be broken down into more detail! Maybe your focus for day 1 can be “don’t order a pizza tonight” – cook at home instead!
Permit yourself to lower the stakes for success and failure for your goals. If you want to be a professor as your long-term career goal, that may require a master’s degree. It’s not possible to complete the master’s degree by midnight tonight, but you can look for a new job that offers tuition reimbursement for your master’s program. If you shift your definition of success to be an outcome you can actually complete today, you will be successful more frequently.
When you intentionally focus on smaller goals, you won’t be ignoring your long-term dream. But, you will feel happier and more focused on each step along the way.
Do something stressful — it can be valuable and fulfilling
We often hear that chronic stress can be unhealthy. But, the right amount of “good stress” can help you feel motivated, resilient, and focused. You can even turn bad stress into good stress by thinking positively about the possible benefits of the situation.
If you’re not deeply cutting your spending to pay off debt, consider pushing yourself a bit towards your other goals — especially if you’re early on in your wealth-building journey. Is there something you can give up in the short-term, even if it’s mildly stressful?
If you’re trying to start a freelance writing business as a side hustle, don’t be afraid to sign up for a training course, even if it might be challenging or expensive in the short-term.
If you’re considering retiring and your finances are in order, go for it! Perhaps it is intimidating at first, but the transition away from your career can yield greater fruits in a fulfilling new chapter of your life.
You will be rewarded in the long-term, and also get relief from endorphins along the way as you push through each step towards your goals.
Seek moments of unity and trust
Do you have family members or friends who are pursuing common financial goals with you? Working with others towards a common purpose isn’t just a pleasant idea. You’ll experience a real rush of oxytocin and gratification when you reach milestones along the way.
Even a pat on the back or a supportive hug can send out oxytocin that helps to dissolve the short-term stress and pain.
The good feelings can result in a real increase in productivity too. A 2014 Stanford study found that when people were treated as though they were working together, they persisted 48 to 64 percent longer on challenging tasks.
Remember how these chemicals can act as antidepressants? Social support is also important for those fighting depression so that you will benefit on that front as well!
Consider sharing your goals or struggles with your spouse or partner, or participating in online communities that have similar interests. This will hold you accountable, but it will also make the moments of celebration even more gratifying.
The empowering conclusion here is that you’re not stuck with a fixed amount of these seemingly magic chemicals. Certainly, people can naturally have varying levels, but you can also set yourself up to experience motivation and gratification.
Whatever your financial and personal ambitions are, I encourage you to set small goals often.
Then pursue them, achieve them, and feel good!
This article was originally published on The Money Mix and re-published with permission.
Mr. SR writes about personal finance, behavioral economics, and early retirement. He has a bachelor of science degree in business marketing and will complete his master of science in business marketing in 2020. Mr. SR has been featured by The Money Mix and Your Money Geek and maintains his own blog, Semi Retire Plan.
Steve is a 37-year-old early retiree who writes about the intersection of happiness and financial independence. Steve is a regular contributor to MarketWatch, CNBC, and The Ladders. He lives full-time in his 30′ Airstream Classic and travels the country with his wife Courtney and two rescued dogs.