What is it?
It’s a debt repayment strategy where you pay off the smallest debt first, then move on to pay off higher debts.
How does it work?
It works by first paying the minimum payments for all your existing debts.
Then sorting all the debts you have in the order of balance while the smallest balance being at the top and the highest being at the bottom.
Example
For example, if you got 4 debts, one is consumer debt, second one is personal loan debt, another one is another personal loan debt and the fourth one is the credit card debt. Lets say, you got $100,200,300, 400 of total debt and the minimum payments of 10, 20, 30, 40 $ for each of them monthly. Now first sort it in the order of balance while the smallest at the top and the highest at the last. So here we will sort it and its like: $100, then 200, then 300, then 400. First, pay the minimum to all the debts, which are 10+20+30+40 = $100. Then allocate extra cash to pay off the smallest debt first. Lets say you allocate $30 for debt repayment. Now, that minimum payment of 10$ + this extra 30$ will go towards paying off the smallest debt which is 100$, so $40 paid off to the first debt in the list and in 1 month, it will be paid off and then we will move on to the second debt, which is $200. Now we will pay minimum for all the three existing ones, and remember we paid off the $100 one. So in the next month, we will pay minimum payments and allot the extra cash + the minimum amount we paid for the 1st debt which is $10 to the second highest debt amount which is $200. Now this becomes first debt minimum payment of $10 +$20 second minimum payment for second debt + $30 extra for debt totalling $60 paid to the $200 debt. Like you can see, the debts will be paid one by one and the amount snowballs from the previous debt amount leading to a bigger amount which can tackle the highest debt in the future.
Pros
- Gives a sense of accomplishments with debt repayments.
- No big hit in the budget because of focusing on the smaller debt first.
- One does Not have to involve yourself with the APRs of the debts.
Cons
- It takes longer to pay off the highest interest rate debt because it has no effect on the high interest rate debts,thus you could be paying more every month towards debt as a whole.
- Increases unnecessary spending due to allocation of small amounts to debt repayment that could effectively go into other debts repayments.