Wednesday, January 12, 2011

SNOWBALL

"A method of efficient debt repayment in which the debtholder initially devotes only enough funds to cover the minimum payments on each debt, after which any remaining available funds from the debt repayment budget are spent on an additional payment to the debt bearing the highest interest rate. Once the debt with the highest interest rate is completely paid for, subsequent extra debt payments go toward the next highest interest-bearing debt. This process continues until all the debts are paid off."

Consider the following example

Let's say an individual decides to spend Rs.500 every month on retiring his three sources of debt: Rs. 1,000 worth of credit card debt (annual rate of 20% interest), Rs. 1,250 of car loan repayments (annual rate of 6% interest) and a Rs. 5,000 line of credit (annual rate of 8%). Each has a minimum payment of Rs. 50.

If the person decides to use the snowball method of debt repayment, he will spend a total of Rs. 150 on paying each debt's minimum payment (Rs.50 x 3). The remaining Rs. 350 will be spent on a payment toward the highest interest-bearing debt - in this case, the credit card debt. Once the credit card debt has been completely paid for, the extra payment will go toward retiring the second-highest interest bearing debt (the line of credit), and the loan with the lowest rate of interest (the car loan).

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