Are you feeling really down and tired of multiple debts with high interest rates? You’re not alone. In fact, the average American has over $90,000 in debt combined with credit card debt, student loans, and other financial responsibilities. That can feel like a mountain of debt, but there’s a plan for battling back: the debt avalanche method.
While other methods concentrate on the smallest balances first, the debt avalanche attacks from the opposite angle. It goes after loans charging you the most interest and saving you lots of money in interest that can be used to pay off your debts even more quickly. Keep reading to learn more about how the debt avalanche works and why it could be the answer to your money problems.
What Is the Debt Avalanche Method?
The debt avalanche method is a debt repayment strategy wherein the borrowers prioritize paying back their loans with the highest interest rates before others. By paying off the most expensive debts first, you can reduce the total interest paid on varying types of debt. It will also speed up your journey to be debt-free. This approach is in stark contrast to the debt snowball method, which focuses on paying off the smallest debts regardless of interest rate.
The debt avalanche method: This method is centered on the interest rate of debts. Additionally, you begin with the one that has the highest interest rate and make minimum payments to all your other debts.
The credit card debt, with a rate of 20%, student loan at 6%, and car loan at 4% – then you would do everything possible to pay off the credit card debt first.
Why Is It Called “Debt Avalanche”?
The term “debt avalanche” is like the natural event of an avalanche, where something small can lead to a big, fast-moving cascade. Basically, just as an avalanche starts at the top of a mountain, the debt avalanche method targets the highest interest rates first. Paying these off first stops them from growing larger and harder to manage.
Like an avalanche picks up speed as it goes downhill, the debt avalanche method gains financial momentum. Each time you pay off a high-interest debt, you free up more money to tackle the next one, speeding up the process. Just as an avalanche clears everything in its path, the debt avalanche method gets rid of high-interest costs that can pile up and weigh you down. As a result, this helps you pay off your debts faster and gain financial freedom.
You May Also Like: 5 Ways to Get Out of Debt
How Does the Debt Avalanche Method Work?
The debt avalanche method is a systematic approach to paying off debt that focuses on minimizing interest costs and paying off debts efficiently. Here’s a step-by-step guide to how the debt avalanche method works:
List All Debts
Start by making a list of all your debts. Include details such as the type of debt (e.g., credit card, student loan, car loan), the total amount owed, the interest rate, and the minimum monthly payment.
Example:
– Credit Card Debt: $5,000 at 20% interest, minimum payment of $150
– Student Loan: $10,000 at 6% interest, minimum payment of $100
– Car Loan: $8,000 at 4% interest, minimum payment of $200
Prioritize Debts by Interest Rate
List all of your debts in descending order by the interest rate you’re charged. The rule of thumb is to tackle the highest rate of interest first.
Example:
1. Credit Card Debt: $5,000 at 20% interest
2. Student Loan: $10,000 at 6% interest
3. Car Loan: $8,000 at 4% interest
Make Minimum Payments on All Debts
Make sure that you keep up with the minimum monthly loan payments on all of your debts to avoid ever-increasing late fees and penalties. This way, your accounts are not 90+ days late while you work on getting the highest-interest debt paid down.
Example:
– $150 on the credit card
– $100 on the student loan
– $200 on the car loan
Allocate Extra Funds to Highest-Interest Debt
Apply any extra money you have each month to the debt with the highest interest rate. This could come from cutting back on discretionary spending. Alternatively, you could earn extra income. Another option is reallocating funds from other areas of your budget.
Indeed, if you have an extra $200 from reducing dining out and entertainment expenses, add this amount to the $150 minimum payment on your credit card debt. Your total payment toward the credit card would be $350.
Repeat the Process
Knock one out, then re-focus on the next debt in your queue. Carry out the same strategy of paying minimums on all other debts & overfunding your additional to your next highest interest.
Next, instead of paying off the $17,000 loan with 4% interest, you direct all extra money to pay off the $5,000 credit card debt. You can only make the minimum payment on the student loan, which had a rate of 6%. Take that $350 you were paying directed toward the credit card and use it to pay down the student loan instead.
Read More: How to Successfully Deal with Credit Card Debt
Advantages of the Debt Avalanche Method
There are several advantages to using the debt avalanche methodology when it comes to tackling your debt head-on. The goal is to provide a clear understanding of the advantages. As an investor, this helps strengthen your commitment. Consequently, you can reach financial freedom faster. Here are the key benefits:
Minimize Interest Payments with the Debt Avalanche Method
The debt avalanche method focuses on paying the debt accounts that have the highest interest rates. Paying off high-interest debts lowers the total amount of interest you pay on your loans. Moreover, it can provide significant savings over other methods of debt repayment.
If you have a credit card debt at 20% interest and a student loan at 6% interest, paying off the credit card debt first will save you more in interest payments.
Faster Debt Elimination
Lowering your interest cost can help make more of your payments go towards paying down the principal balances on your debts.
This certainly makes the debt pay-down process even faster, meaning you can be 100% debt-free even sooner. The more interest compounds on your balance, the longer it will take to pay off the principal (what you actually owe).
You will pay off all of your debts faster and with less interest if you always prioritize high-interest debts over low-interest debts.
Improved Financial Discipline
With the debt avalanche method, you take a more strategic approach to paying off your debts by targeting higher interest rates first and making consistent, aggressive payments.
This actually promotes healthy money habits and financial discipline. It will encourage careful budgeting and save money to help pay back debt.
Devoting more money to debt service rather than discretionary spending in order to pay high interest rates teaches you to spend carefully.
Psychological Benefits of Debt Avalanche Method
The debt avalanche method is complete with a very powerful psychological benefit.
Then, every time you see your high-interest debt decrease significantly, it can serve as a reminder to keep going. Understanding that you are paying less in interest can also boost your financial confidence.
Being able to see the balance on a 29.9% credit card drop like mad is pretty powerful and will keep you working to get that repaid.
Long-Term Financial Health
Overall, the debt avalanche method can be a welcome reprieve from high fees and fast-track your way out of debt.
Paying off your debt sooner and paying less for interest enables you to put money towards other financial needs (such as saving for retirement, investing, or creating an emergency fund).
You should be able to do it when your high-interest debts are cleared and invest this extra money in your retirement account while giving you more money cushion for the future.
You May Also Like: Types of Budgeting: Simple Strategies to Improve Handling Your Money
Disadvantages of the Debt Avalanche Method
While the debt avalanche method has many benefits, it also comes with certain drawbacks. Understanding these disadvantages can help you decide if this debt repayment strategy is right for you. Here are some potential challenges of the debt avalanche method:
Requires Patience and Discipline
Unlike the debt snowball method, which targets debts with the lowest balances first, the debt avalanche method tackles balances with the highest interest rates first.
It can appear less immediate than the avalanche technique, wherein smaller, lower-balance loans are paid off first. If you have a large number of debts that are all relatively small, it can take a great deal of discipline and patience to stick to the plan.
Lack of Immediate Rewards
Older debts in collections that have not been validated and disputed for a long time normally continue to collect those high-interest fees.
It may be demotivating to see little to no progress in the long term. While it may feel like this method doesn’t provide quick wins, the debt snowball method does. By paying off the smallest debts first, you get little victories along the way. However, with the debt avalanche method, you might wait longer for that sense of accomplishment.
For instance, the debt snowball method can push you to pay off small debts swiftly. This gives you a sense of completion. In contrast, with the debt avalanche method, success feels distant until larger, higher-interest debts are reduced.
Hard to Implement
The avalanche method means that you order your debts by interest rate and tackle the one with the highest first. This can be harder to implement and administer than just ranking liabilities by amount. Among the many debts you have to track, figuring out where to start and if you are paying in the right way is a big task.
For example, it can be difficult to keep track of an accurate repayment plan if you have multiple debts with different interest rates and balances without keeping detailed records.
Budget Constraints
The debt avalanche method is the process of assigning extra money to your debts in order to pay off high-interest debts first. Allocating additional money every month towards your highest-interest debt can be challenging if you are already living on a tight budget. This might require substantial changes in way of life or other sources of income, or it can be tedious.
For example, if you are already having a hard time keeping up with your bills each month, it will be difficult to come up with extra funds to pay down your most expensive debt faster, which will slow the process.
Emotional Impact
Saving for the long-term vs getting a quick win can be un-motivating. It can be emotionally brutal not to see anything for a while (especially in fiction). Feeling stuck can be frustrating, and if not careful, many will abandon the plan far before they see the rest of their dividends.
Read More: What Is a Do-It-Yourself Debt Strategy? Check If It Works For You
Conclusion
A great way to reduce your interest payments and become debt-free is the debt avalanche method. This approach comes at a price. It involves time, patience, and discipline. It does not return instant rewards. Moreover, it is relatively difficult to implement. You may face economic constraints. It can affect your motivation. Understanding these pitfalls allows for informed decisions. This helps determine if the debt avalanche method suits your finances and personality. For those who choose this route, maintaining consistency is key. Seeing the light at the end of the tunnel can help you reach your goal. Ultimately, you aim to live as a debt-free individual.
