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The Debt Avalanche Method Explained

If you’ve heard of the debt avalanche method, you might be confused as to how it differs from the debt snowball method. Maybe you’re facing a mountain of debt, and you’re looking at how to pay it off with the least amount of struggle.

Debt interferes with daily life and costs us freedom financially. You know you need to pay off your debt, and you’ve been trying to avoid bankruptcy and credit counseling programs.

The problem is, most of the common information you’ve heard about paying off debt seems to ignore one thing: the interest rate.

While the snowball method instructs you to list your biggest debt first and disregard interest, the avalanche method takes a more mathematical approach.

Here’s what both debt management plans have in common: They require that you:

  1. Stop Borrowing Money. You can’t pay off debt if you’re still taking out loans and buying things with credit. You’ll need to cut your budget down to a cash-only plan by reducing expenses.
  2. Have Laser-Focus on Debt. Cancel everything that gets in the way of paying off your debt. This means you don’t invest in stocks, you don’t take an expensive vacation, and you don’t decide to remodel the house. All spare cash goes into your debt program.

Ultimately, the best method is the one you’re more likely to stick with, but you’ll need the details to make an educated decision. By the end of this article, you’ll have a good explanation of the debt avalanche method and whether it’s right for you.

How the Debt Avalanche Method Works

The idea of the debt avalanche method is simple. You place the highest-interest debt at the top of a list and pay them off first. Meanwhile, you make minimum payments to all other creditors at the same time. This way, you minimize the rate of interest accrual by deprioritizing the lower interest debt.

When you pay off your first debt, you give yourself a pat on the back and move your focus to the second debt on the list. You then use the amount that you were paying on the first debt and add it to the second.

If you keep following this method, you’ll have eventually tackled the entire list while paying minimal interest to your creditors.

The main benefit of this method is that you are saving money because you’re paying less interest. The avalanche method will be the perfect plan for you if you can’t stand high-interest rates and giving too much money to your creditors.

You’re likely to have success with the avalanche method if you are:

  • You’re not swayed by short-term gratification or emotional purchases. You’re in it for the long-haul, and you know that if you stay on track, you’ll come out ahead.
  • Detail-Oriented. You make good decisions when you have the facts and numbers at hand. Keeping track of personal finances is a numbers game that you can win if you do your calculations correctly.
  • Tactical and Deliberate. You can’t stand throwing more money at your creditors than they deserve. With a smart plan and solid follow-through, you can save money and pay off debt quicker.

Let’s take an example list of four debts. We’ll say that you are willing to throw in an extra $999 more than the minimum payments each month to pay off debt. Here are the four debts using the debt snowball method:

Debt Snowball Method

The Debt:

Debt A: $4,569 for a car loan with a 6% interest rate and $435 monthly minimum payments.

Debt B: $11,859 in personal loan debt with a 7.6% interest rate and $315 monthly minimum payments.

Debt C. $12,119 in credit card debt with a 16% interest rate and $300 monthly minimum payments.

Debt D. $163,845 in school loans with a 4.750% interest rate and $770 monthly minimum payments.

The Results:

Debt Total (Principal): $192,392

Monthly Payments Total (Minimum Payment of $1820 plus an extra $999): $2819

Payoff Date: February 2024

Interest Paid: $34,429.49

The total amount of interest paid was $34,429.49 with the snowball method. Not pretty. Let’s check the avalanche plan.

Notice that Debts A, B, and C are switched according to highest interest first in the list below:

Debt Avalanche Method

The Debt:

Debt C. $12,119 in credit card debt with a 16% interest rate and $300 monthly minimum payments.

Debt B: $11, 859 in personal loan debt with a 7.6% interest rate and $315 monthly minimum payments.

Debt A: $4,569 for a car loan with a 6% interest rate and $435 monthly minimum payments.

Debt D. $163, 845 in school loans with a 4.750% interest rate and $770 monthly minimum payments.

The Results:

Debt Total (Principal): $192,392

Monthly Payments Total (Minimum Payment of $1820 plus an extra $999): $2819

Payoff Date: February 2024

Interest Paid: $33,660.79

See the difference? The total time to pay off the debt stayed the same when comparing the two methods, but the interest paid changed.

The interest on the avalanche method is not pretty either, but paying off the debt in the debt avalanche order would have saved you a total of $768.70 in interest payments.

The results can be more extreme if you have several high-interest rate loans. Sometimes the debt avalanche method can shave off a few months from repayment time too.

Using an Excel spreadsheet will allow you to add a new sheet for each month so you can go back to check progress quickly and see how far you’ve come.

Conclusion

Using the debt avalanche method can save you money and time in paying your creditors. It might take you longer to pay off the first debts on the list than if you’d used the snowball method, so there is no quick emotional gratification. But knowing that you’re minimizing interest payments to your creditors may be just as rewarding.

Ultimately, the goal is to pay your way to financial freedom by choosing the best debt plan that works for you.

Pay Down Multiple Forms of Debt – The Smart Way

When you have multiple debts, it can seem impossible to keep up with the minimum repayments, let alone make headway. In some cases, just $1,000 on a credit card can take almost 25 years to pay down if you are only making the minimum payments. To get ahead of your debts, you need to know how much you owe, what the minimum repayments are, and what the interest rate is. Once you know that, you can look at tackling your debts head on.

Define the Problem

Step one to crushing your debts is to define the problem. While you might know that you owe $50,000 across various loans and credit cards, this information won’t help you to get ahead. Sit down and go through all your payments until you can make yourself a list of exactly how much you owe, who you owe it to, and when they expect to be paid. Then find out the interest rates for each debt and you should end up with a list something like this:

  Owing Min. Monthly Payment Interest Rate Time to Repay
Credit Card #1 $5,000 $100 20% 9 years
Credit Card #2 $800 $25 13.25% 3 years
Car Loan $12,000 $250 7.99% 5 years
Personal Loan $10,000 $150 4.59% 7 years

 

In this example, you need to make minimum repayments of $525. Over the life of the loans you will be paying over $10,000 in interest. To shorten this term, go over your budget and see how much extra you can put towards different sources of debt. Even $100 a month could save you thousands.

Approach Repayments with your Head, Not your Heart

Now that you have defined the problem, there are a few approaches you could take. You can put a little extra into each loan, pay down the smallest balance first, or pay down the debt with the greatest interest rate first. First, consider whether a balance transfer credit card suits your needs. If you cannot find a way to lower your rates, then start tackling debt with the highest interest rate first. While you might want to start with the smaller debts, knocking down the high interest ones will save you the most money over the life of your debt.

In the above example, if you start by paying down the 20 percent APR credit card debt, you will save $3,481 and knock more than six years off of repayment. Once that card is paid, you will have another $100 a month free that you can put towards closing out your second card.

When you have paid down your credit cards, you will have approximately two years left on the car loan. Take the $225 a month from your credit card repayments and put it towards your car loan. You’ll shorten the loan by a year and save close to $300.

Finally, take $340 a month from your other loan repayments and tackle your personal loan. The increased repayments will knock two years off the life of the loan.

By snowballing your debt repayments starting with the highest interest rate, you can cut both the repayment time and the total interest paid in half. While it might seem like a daunting place to start from, every dollar makes a difference, and once you get started momentum picks up quickly. Just like in this example, the first step is the hardest, and the first debt takes the longest. Despite this, by you’ll see your debts rapidly melt away by sticking to a solid plan.

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