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A debt avalanche may sound like a bad thing. But, if you’re trying to pay off debt, it’s actually a very good thing. It will help you pay down your debt faster and save money on interest.
Let’s take a look at how the Debt Avalanche can work for you.
How Does the Debt Avalanche Work?
With the Debt Avalanche method, you pay off your non-mortgage debts in order from highest interest rate to lowest. (This is different from the Debt Snowball method, where you pay off your non-mortgage debts in order from smallest to largest.)
Once you pay off the debt with the highest interest rate, you take the money you were paying towards that loan and roll it over towards the debt with the next highest interest rate.
Like the Debt Snowball method, the amount you pay towards each debt will increase as you pay off the other debts. This will allow you to pay off the next debt faster.
But, by focusing on paying higher-interest rate debt first, you’ll decrease the amount of interest accruing. Which means you’ll pay less in interest.
The Debt Avalanche in 5 Easy Steps
Step 1 - List all of your non-mortgage debts from highest interest rate to lowest interest rate.
Non-mortgage debt includes credit card debt, car loans, personal loans, student loans, loans from your retirement account, medical debt, etc.
Step 2 - Pay minimum payments on all your debts each month.
Step 3 - Put all extra money towards the debt with the highest interest rate.
To help you pay down your debt faster, put all extra money towards your highest-interest rate debt. Examples of where this extra money can come from include:
- Income from taking surveys
- Tax refund
- Money left over at the end of the month (i.e., you budgeted $400 to groceries but only spent $375, giving you $25 left over)
- Finding ways to trim expenses
- Finding ways to earn extra money
Step 4 - Once the debt with the highest interest rate is paid off, take minimum payment plus all extra money and put it towards your next highest-interest rate debt.
Step 5 - Repeat until all debts are paid in full!
The Debt Avalanche in Action
Say you have the following debts:
- $7,900 Car Loan ($100 monthly payment, 5% interest)
- $14,000 Student Loan ($100 monthly payment, 6.8% interest)
- $3,500 Credit Card #1 ($100 monthly payment, 18% interest)
- $1,000 Credit Card #2 ($50 monthly payment, 16% interest)
[Note: For the purpose of this example, we will ignore accruing interest.]
First, you’ll want to list them in order, from highest interest rate to lowest.
So, you’ll pay the minimum payment each month on each loan. But you’ll put all extra money towards the highest-interest rate debt...in this case “Credit Card #1”.
For this example, let’s say you are able to put an extra $150 towards your loans each month. So, your monthly payment plan would look like this:
You’ll be able to pay off Credit Card #1 in 14 months (instead of 35 months). Starting in Month 15, you’ll take the $250 you were paying towards Credit Card #1 and add it to the $50 you are paying towards Credit Card #2. So, your monthly payment plan would look like this:
You’ll have Credit Card #2 paid off in 1 months (instead of 3 months). Then, starting in Month 16, you’ll add the $300 you were paying towards Credit Card #1 and add it to the $100 you are paying towards the Student loan. So, now your monthly payment plan would look like this:
With paying $390 towards your car loan, you’ll have it paid off in 32 months (instead of 125 months). (You’ll actually only need to put $100 towards your student loan in Month 47. Therefore, you’ll be able to put the remaining $300 towards your car loan that month.)
Then, starting in Month 48, you’ll take the $400 you were paying towards the Student loan and add it to the $100 you are putting towards your Car loan. Here’s what your monthly payment plan would look like this:
With your payment of $500 towards the student loan, you’ll have it paid off in 6 months (instead of 30 months). This will allow you to be fully debt free in 53 months (instead of 193 months).
Is the Debt Avalanche Right for You?
Pay less in interest. With the Debt Avalanche, you are paying off debts with higher interest rates before debts with lower interest rates. So, the higher interest loans will accrue less in interest. This will allow you to pay less in interest and pay down principal faster.
May take more time to pay first debt. The Debt Avalanche ignores the amount of your debt. So, by paying on your highest-interest rate debt first, you may be paying off debts with larger balances before debts with lower balances.
At first, this may mean that it will take longer to pay off the first debt. In our example, with the Debt Avalanche method, it took 14 months to pay off the first debt. But, with the Debt Snowball, it only took 5 months to pay off the first debt.
Because it may take longer to pay off the first debt, you’re less likely to get that motivational “quick win” that you’d get with the Debt Snowball. This could lead you to lose motivation and cause you to stray from your payoff plan.
As you can see, using the Debt Avalanche can help you reach your debt-free goal faster. And by paying your highest-interest rate debt first, you’ll pay less in interest. But it may cause you to lose motivation if it takes a while to pay off that first debt.
Only you can decide what is more important to you.
What debt are you currently tackling? Why?