The Snowball is a buy and hold property strategy. The idea of the snow ball is very simple: purchase enough properties to make the investor financially free once they are all paid off. These properties can be Cash flow Positive, Cash flow Neutral or even Cash flow Negative, as long as the investor has a decent amount available above living costs and any additional costs imposed by these properties. It does work best with positively geared properties.
The Snowball works by plunging as much as is possible from the investor’s salary/wages into paying down the loan principal on their properties. As their overall mortgage decreases, the investor can then re-invest the money that would have been paying the mortgage interest, but rather into paying down the loan principal on their properties, faster and faster (thus snowballing). In effect this is compound interest, but with properties.
Suppose that someone has 5 properties each of which costed $100000 and return $200 so they have a mortgage of $500000 in total. Suppose by scrimping they can save about $500 a week to pay down their mortgage and the properties are cashflow neutral on 25 year mortgages at 10% interest. In the first year they save $25000 to pay down their mortgages, and their properties pay themselves down by about $7500.
So their mortgage has reduced to $467500
They were paying $50000 in mortgage repayments for interest alone now they are only paying $46750
So they can now pay down the mortgage by $29750 + $7500
So after year 2 the mortgage is: $430250
In year 3 they can pay: $31975 + $7500
Mortgage = $390775
In year 4 they can pay: $35922 + $7500
Mortgage = $347352
In year 5 they can pay: $40264 + $7500
Mortgage = $299587
In year 6 they can pay: $45042 + $7500
Mortgage = $247045
In year 7 they can pay: $50295 + $7500
Mortgage = $189249
In year 8 they can pay: $56075 + $7500
Mortgage = $125673
In year 9 they can pay: $62432 + $7500
Mortgage = $55740
In year 10 the properties are paid off.
NB Figures are simplified and do not represent proper compounding, if this was taken into consideration it would snowball even faster. However tax would slow it down. (Depending on depreciation).
Part of the Property Cycle it best suits
The part of the property cycle this strategy suits best is slumps since this is when it is easiest to pick up cashflow positive properties that aren’t complete dogs. However it can be done at any point in the cycle because of the decreasing loan to value ratio and increasing cashflow. The time scale for this strategy is medium term, about 10 years.
This strategy is very low risk. This is because the loan to value ratio constantly decreasing and the income increasing. The point of highest risk is at the initial point of purchasing all the properties.
This strategy is reasonably slow compared to higher risk strategies. It also requires considerable personal outlay of cash in the above example $250000.
Optimising the Strategy
There are trade offs between which properties to pay off first. Roughly the first should be the family home. Secondly you should probably pay down any properties up to the maximum amount you can without penalty (most banks this is 5%). Finally the properties with the highest interest rates first.