Here’s an explanation of the Snowball Method, in a way relatable to us Malaysians, so you can use it to pay off your debt, or advise someone about it.
Meet Puteri* (not her real name)
Puteri is a university graduate who works in KL. She owes money to a few financial institutions and her family.
Puteri’s debts:
- Car loan – borrowed RM36,000 with 3% interest; balance RM20,000
- Credit card – borrowed RM1,000 with 9% interest; balance RM1,000
- FAMA Bank (Bank of Father and Mother) – borrowed RM1,500 with 0% interest, balance RM1,500
- PTPTN education loan – borrowed RM50,000 with 1% interest; balance RM40,000
- Personal loan – borrowed RM10,000 with 12% interest; balance RM8,000
(*interest rates taken from various comparison websites)
The logical approach when paying off debt is to prioritise repayment of the highest interest loan first before paying off the next one. If that’s the case, Puteri’s order is:
- Personal loan – 12% interest
- Credit card – 9% interest
- Car loan – 3% interest
- PTPTN – 1% interest
- FAMA Bank – 0% interest
It makes sense, right? This way Puteri gets to pay the least amount of overall interest. Now, that’s a rational solution.
Ok, here’s the thing. Math-wise it’s rational. Humans are not as rational, though. Dave Ramsey and a bunch of Harvard researchers say it’s better to prioritise debt in the order of their “balances” instead.
If you re-order Puteri’s loans by their balances, it’ll look like this:
- Credit card – balance RM1,000
- FAMA Bank – balance RM1,500
- Personal loan – balance RM8,000
- Car loan – balance RM20,000
- PTPTN education loan – balance RM40,000
Why should Puteri pay off her credit card balance first if her personal loan has a higher interest rate? Because ticking off debt one by one gives you more motivation to keep it up.
Say Puteri pays off her lowest debt i.e. her credit card. Now it’ll look like this:
- Credit card – balance RM1,000 (Paid off in full)
- FAMA Bank (minimum payment to indicate goodwill)
- Personal loan – balance RM8,000 (minimum payment to avoid further interest)
- Car loan – balance RM20,000 (minimum payment to avoid further interest)
- PTPTN education loan – balance RM40,000 (minimum payment to avoid further interest)
For most people, crossing out even one loan can give them lots of satisfaction and motivation to keep going.
Then Puteri can do the same thing for the rest:
- FAMA Bank – balance RM1,500 (put in extra money to pay this off in the quickest timeframe)
- Personal loan – balance RM8,000 (minimum payment to avoid further interest)
- Car loan – balance RM20,000 (minimum payment to avoid further interest)
- PTPTN education loan – balance RM40,000 (minimum payment to avoid further interest)
And so on and so forth. Whichever debt has the lowest balance, pay that off first.
General tips and tricks in paying off debt
- Always find out if there are opportunities to reduce your loan balance.
For example, PTPTN offers a 15% discount on one-off total repayments. There might be a balance transfer plan that gives better rates. Then re-order according to the new balance.
- Check if there are penalties to paying off loans early.
If there is, add it to the balance and re-order.
- Don’t get another (bad) loan.
Avoid racking up more debt, especially credit card and personal loan debt.
- Try to not skip minimum payments.
Unless you’re really short on cash and can’t trim your budget any further. If you have to miss a payment, try giving each institution a call to see if you can renegotiate terms – ask for a smaller payment or an extension. It’s worth a shot.
If not, ask the FAMA Bank. If not, it’s ok, it’s not the end of the world. Ask AKPK and see if they can intervene and help in any way.
- Find ways to increase income and reduce expenses.
Chuck all your extra money to repayments so you’ll get out of debt faster.
- If the interest rate is really small (0-1%), it’s OK to split your money and use a portion of it to start investing.
You can start investing even with only RM1,000.
- Never take advantage of FAMA Bank.
It’s a sin!
This article first appeared in ringgitohringgit.com
Suraya is a corporate writer-for-hire and the blogger behind personal finance website Ringgit Oh Ringgit. She is more of a minimalist, less of a consumerist, a konon DIY enthusiast, a let’s-support-small-businesses-over-big-corporations kinda girl. Prior to her current role, she worked in various capacities within the non-profit industry.