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The Debt Avalanche: One Smart Way to Pay Off Your Debt
The debt avalanche method may help you defeat debt.
According to a recent study by Intuit Credit Karma, millennials carried an average of $48,611 in total debt.1 Surprisingly, millennials trail behind other generations when it comes to debt; Gen X’s average was $61,036 and Baby Boomers were $52,401.2
While some debt, such as a mortgage to buy a house or college loans, is often inevitable, other types of debt, such as credit cards, could actually deter you from achieving your financial goals.
One powerful tool in your debt payoff arsenal is the debt avalanche method, which prioritizes paying off the highest interest debts first.
Let's dive into the debt avalanche method, how it works, and its advantages compared to other debt payoff methods.
Key Takeaways
The debt avalanche method may help save you money by prioritizing the highest interest debts first.
It's a smart choice if you want to minimize interest costs, even though it may take longer to pay off the first balance.
There are also other debt payoff strategies, like the debt snowball method, debt consolidation loans, or balance transfers.
What is the Debt Avalanche Method?
The debt avalanche method is a debt repayment strategy that prioritizes paying off the highest rate debts first. These rates are typically expressed as Annual Percentage Rates or APRs. By targeting high-interest debts, you may minimize interest fees and accelerate your progress towards reducing your debt.
The avalanche method empowers you to make strategic decisions about your debt and potentially save money in the long run.
When using the debt avalanche method, it's important to note that mortgage debt is typically not included as part of the payoff strategy. This is because mortgages often carry lower rates and longer terms than the high interest debts this method focuses on tackling. Also, because mortgages are secured by an asset that could appreciate, many view mortgages as a smart way to use debt.
Steps to the Debt Avalanche Method
If you’re looking to implement the debt avalanche method effectively, try using the following steps.
Step 1: List Your Debts
Gather all the necessary information about the debts you’re looking to pay off, including credit cards, loans, and other outstanding balances, such as medical bills. Make a comprehensive list that includes each debt, rates, and minimum payments.
Step 2: Create a Budget
Whether you’re creating a new budget or adjusting an existing one, it’s important to determine how much you are able to allocate towards your debt payments while still meeting your essential expenses and savings goals.
Ideally this amount will be higher than the total of the minimum payments you owe on your debts.
As part of this exercise, it may be worth tracking your expenses for a time to determine if there are any areas where you may be able to reduce your spending and reallocate those funds toward debt pay off.
Step 3: Focus on the Highest Interest
Once you have your budget in place, begin making payments on each of your debts. For the debt with the highest rate, pay more than the minimum payment until it is fully paid off. Make the minimum payments on the rest of your debts to prevent any late fees.
Step 4: Reallocate Funds to the Next Debt
After you pay off the highest interest debt completely, take the funds that were previously allocated to that debt and redirect them towards the debt with the next highest rate.
By maintaining the same overall debt payment amount each month, you may accelerate your progress and pay off subsequent debts more quickly.
Debt Avalanche Example
To illustrate this method, let's consider an example. Suppose you have $800 each month to allocate to the following debts. Please note the following numbers are for illustration purposes only.
Debt A: Credit card with a rate of 24.00% APR, balance of $5,000, and a minimum payment of $100.
Debt B: Credit card with an interest rate of 20.00% APR, balance of $15,000, and a minimum payment of $200.
Debt C: Car loan with an interest rate of 8.00% APR, balance of $10,000, and a minimum payment of $150.
Using the debt avalanche method, you would prioritize Debt A as it carries the highest rate. Each month you would make the minimum payments on Debts B and C (a total of $350), and you would allocate the remainder of your funds towards Debt A ($450) until it is fully paid off.
Once Debt A is fully paid off, you would direct the funds that were previously allocated to it towards Debt B, making the monthly payment $650, which would speed up the repayment process.
Finally, you would focus on Debt C, using the combined payments from the previously paid-off debts to pay it off faster.
Is the Debt Avalanche Method Right for You?
The debt avalanche method works best for people who want to save on interest fees and don’t mind waiting a little longer to see a debt fully paid off.
If you have multiple high-interest debts and are motivated to minimize interest costs, this method can be a great fit.
Debt Avalanche vs. Debt Snowball
When it comes to debt payoff methods, the debt avalanche method is often compared to the debt snowball method. While both methods aim to help you reduce your debt, they differ in their approach. The debt avalanche method focuses on rates, while the debt snowball method prioritizes paying off the smallest debts first.
Let's take a look at the pros and cons of each method.
Method | Pros | Cons | Best for |
|---|---|---|---|
Debt Avalanche | Minimize interest fees by tackling highest interest debt first May reduce time it takes to pay off debts | Takes longer to pay off first balance May require more motivation to sustain | People who prioritize saving money and want to minimize interest costs. |
Debt Snowball | Offers motivation through small wins Easy to implement by starting with the smallest debt | Doesn’t take rates into consideration May take longer to pay off debts | People who struggle with motivation and prefer the psychological boost of paying off smaller debts early on. |
When choosing between these approaches, think about which would be easier for you to implement and stick to.
If the knowledge that you’re saving money in the long run gets your heart racing, the avalanche method is probably the right choice. On the other hand, if seeing consistent wins helps you stay motivated, using the snowball method may be the better option.
Other Ways to Pay Off Debt
While the debt avalanche and snowball methods are effective strategies for paying off debt, they aren’t the only options.
Two common alternatives for handling debt are balance transfers and debt consolidation loans.
Debt Consolidation Loan: If you have multiple high-interest debts, a debt consolidation loan could be a great solution. It allows you to combine your debts into one loan with a potentially lower rate. This simplifies your repayment process and may reduce the overall interest fees you pay.
Balance Transfers: Another option is transferring your debt to a credit card with a lower rate for a specific period. This may provide temporary relief. However, it's important to be mindful of the terms and fees associated with balance transfers, as they can create a cycle of debt if not managed carefully.
As you embark on your debt repayment journey, consider reaching out to financial professionals or credit counselors who are able to provide guidance and support.
Final Thoughts
Choosing the right debt payoff method may help you on your path to achieving financial freedom. The debt avalanche method offers a strategic approach to tackle high-interest debts and potentially save money in the long run.
Remember, everyone’s financial situation is unique, and it's important to assess your own circumstances before deciding on a debt payoff method. Whether you choose the debt avalanche method, the debt snowball method, or another approach, the key is to take proactive steps towards paying off your debt.