The Debt Snowball Method, FIRE, and Real Estate Investing

The Big Picture On Debt Snowball Method, FIRE, and Real Estate Investing:

• Focus on paying off the smallest debts first while making minimum payments on larger ones.
• Quickly eliminating small debts provides a motivational boost to tackle larger debts.
• List all debts from smallest to largest, allocate extra funds to the smallest debt, and repeat until all debts are cleared.

When you’ve got extra money in your budget for financial goals, should you allocate it toward aggressive debt payoff or invest it? Financial experts love to point to math that shows investing is usually the best place for your money, but that decision proves complicated.

In most cases, you should eliminate high-interest debts like high-interest credit cards before allocating funds toward investments. With interest rates routinely in the 16-25% range, credit card debt quickly spirals out of control.

A popular debt-payoff tactic, the debt snowball method, could help you do that quickly — so you can get on with investing and building wealth.

As you work toward your financial goals, here’s what you need to know about the debt snowball method and its sister, the debt avalanche method.

What Is the Debt Snowball Method?

The debt snowball method, coined by financial guru Dave Ramsey, is a method of debt repayment in which you aggressively pay off your lowest-balance debts first. Eliminating one account with this method frees more money toward the next lowest debt.

So, you roll all additional monthly savings into paying off your next lowest-balance debt. When you eliminate that one, you then tackle the next lowest debt. With each debt you pay off, you have more money to put toward paying down the next one until you’ve paid off all high-interest debts.

For example, say you have three consumer debt accounts:

• A Mastercard with a $3,500 balance and a $35 minimum monthly payment.
• A Discover Card with a $2,000 balance and a $20 minimum monthly payment.
• A personal loan with an $8,000 balance and a $300 monthly payment.

Say you have $500 in your monthly budget for debt repayment. That leaves you with $145 monthly to allocate to debt payoff exceeding the minimum required to avoid late-payment penalties.

Using the debt snowball method, you’d allocate $145 toward the Discover Card until you eliminate the balance.

When the Discover Card balance is gone, you should allocate the $165 you were paying into the Mastercard balance until it’s gone.

When the Mastercard balance is gone, you should allocate the $200 you paid into the personal loan until it’s gone.

The debt snowball technique targets credit cards and other consumer debts, though it can eventually be used to repay any type of debt. From student loans to auto loans to rental property loans, you can use them to build momentum and become completely debt-free.

See how your repayment snowballs as you tick debts off your list?

Potential Pros and Cons of the Debt Snowball Method

The debt snowball method is not without its upsides and downsides. Although nothing major, below are some of the ones you can expect.

Why Does the Debt Snowball Method Work?

The debt snowball method proves effective for two reasons:

• It encourages you to prioritize debt payoff and allocate extra money toward debt instead of spending more.
• Eliminating smaller debts first gives you a much-needed early win in paying off a debt. That tangible progress helps keep you motivated to keep paying off debts.

Repaying debt this way might not be the most financially prudent. Depending on the interest rate on each account, you could spend more money repaying your debt than you’d have to. (More on that momentarily.)

However, the debt snowball method remains popular because it simplifies debt repayment. Most people need those early, motivating successes to continue their debt payoff journey.

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Debt Snowball vs. Debt Avalanche

Some experts recommend the debt avalanche method instead due to its popularity and imperfections.

Like the debt snowball method, you focus on one debt at a time and then roll the savings into the next debt. Instead of starting with your lowest-balance debt, the debt avalanche method starts with your highest-interest debt.

Every month, you carry a balance, and debt grows with interest. The higher the interest rate on an account, the more quickly that balance stands to grow.

The quicker you pay a balance off, the less money you’ll pay in interest.

Revisiting the above example, say your:

• Mastercard has a 19% interest rate.
• Discover Card has a 16% interest rate.
• Personal loan has a 7.5% interest rate.

With the debt avalanche method, you’d put your extra budget toward the Mastercard first, then the Discover Card, and then the personal loan.

The math usually works out in favor of the debt avalanche method — over time, your debts cost less when you eliminate high interest rates first.

But debt payoff is tough to commit to. Study after study has shown that the psychological benefit of closing debt accounts is that it keeps people motivated to continue prioritizing debt payoff, reports Forbes.

It’s why many borrowers see more success with the debt snowball method, even if it costs them more in the long run.

What Is the Snowflaking Method?

The debt snowflake method encourages you to allocate so-called “found money” toward debt repayment, which can then follow either the debt snowball or debt avalanche method.

The debt snowball and avalanche methods assume you allocate a set amount of money in your monthly budget for debt repayment — for example, 10% or 20% of your monthly income.

Snowflaking means allocating money you haven’t accounted for toward debt. This could be small savings or unexpected income, like:

• The total savings from nabbing deals on your weekly grocery trip. (Stores love to do the math for you right on your receipt!)
• $5 savings when you get a free latte with your loyalty card at a coffee shop.
• $300 for re-selling your digital camera.
• $800 in monthly income from a side hustle you don’t rely on to make a living.
• $1,500 in your tax refund.

Add up this extra cash each month and allocate it toward faster debt payoff according to your method of choice.

Snowflaking lets you prioritize debt payoff without cutting into your typical budget. It doesn’t require you to tighten your belt some months just to meet a quota of debt repayment, but it still encourages you to find extra money to allocate toward debt where you can.

The downside? It can leave high-interest debts to fester and grow without an aggressive paydown schedule.

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Debt Snowball & Rental Property Loans

Your mortgage and other rental property loans will likely have high balances and relatively low interest rates so that they won’t be your top priority with either the debt snowball or debt avalanche methods.

However, using these tactics to pay off lingering credit card debt and small loans lets you more quickly turn your focus to those bigger real estate loans. Without losing money on monthly credit card debt payments, you can save up faster for a down payment on your next investment property.

Tackle your high-interest debt early so you can start focusing on building passive income and wealth.

When to Stop Using the Debt Snowball Method

Aggressive debt repayment has a point of diminishing returns. You will likely reach a point where you’re better off allocating an extra monthly budget toward investment rather than debt.

That point is simple to spot: When the interest on your remaining debts is significantly lower than the return you stand to earn by investing, you’re better off re-allocating the money toward investment.

For example, say you eliminate your credit card balances and still have an auto loan at a 4.5% interest rate and a $150,000 rental property loan at a 6% interest rate.

Should you keep the snowball rolling, eliminate that auto loan, and tackle the mortgage debt, or invest your extra funds in a new rental property?

Say that rental property could earn you a 9% return (which you can figure out with our rental property ROI calculator). To save the interest on your debts, you’d give up the potential to pocket another 3% to 4.5%. In this case, investing is usually the smarter place for your money.

Still, it depends on where you are in your career. As you approach retirement, often, it makes more sense to reduce debt rather than invest. You may repay those rental property loans for a guaranteed 6% return and build equity quickly rather than take on more loans and investments.

Accelerating F.I.R.E. Through Real Estate and Debt Snowball Method

Provided that you’ve paid off lingering credit card debt and small loans with the debt snowball method, you can still pursue the approach to achieving FIRE (Financial Independence, Retire Early) through real estate investing. It’s a totally complex operation, but I’ll simplify it as much as I can.

Sequential Mortgage Elimination

Once you acquired multiple rental properties, you can apply the debt snowball method to your real estate portfolio to focus on eliminating the mortgage debt on one property at a time. 

Once the first property is paid off, the increased cash flow from that debt-free asset can be directed toward paying down the mortgage on the next property in line. Of course, the process must continue until the entire portfolio is unencumbered — maximum cash flow for you.

While taking this route may take longer than using extra funds for down payments on additional properties, it offers distinct advantages for those nearing retirement age, such as the following:

• It reduces overall financial risk by systematically eliminating debt obligations.
• It allows you to quickly bypass lender restrictions on the number of mortgages an individual can hold. With the debt snowball method, you can now pay off mortgages faster.
• This method creates a predictable path towards a fully paid-off real estate portfolio.

Reinvest Rental Income for Additional Properties

For those just starting their investment journey, the debt snowball method can be applied alongside using cash flow for portfolio growth. While focusing on paying down one property’s mortgage, you can still use excess cash flow from other properties to save for down payments on additional investments.

For instance, a multi-family rental property generates $12,000 in annual cash flow AFTER expenses, and debt service can provide $60,000 for a down payment on a second property within five years while applying extra payments to the first property’s mortgage. As the portfolio grows, so does the potential for both debt reduction and reinvestment.

As you acquire more properties, you can continue this balanced approach. For example, you might allocate 50% of the cash flow from new properties to accelerate the debt snowball on existing mortgages while using the other 50% to save for future down payments. 

What Are Your Financial Priorities?

The debt snowball method, debt avalanche method, and snowflake method all help you work toward becoming debt-free.

To develop rental property income, however, you must balance a debt-payoff goal with investment goals and risk tolerance. Most scenarios show that investing pays off better in the long run if you have time to weather market volatility.

However, eliminating debt eliminates significant financial stress and leaves you with fewer accounts and due dates to manage monthly. That psychological benefit sometimes outweighs the practical benefit of maximizing returns.

Do the math, but also determine your priorities to make a financial plan that’s right for you.

Have you ever tried the debt snowball method or debt avalanche method? What were your experiences with them?

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