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The Debt Avalanche Method: A Smart Way to Pay Off Your Debt
The debt avalanche method may help you defeat debt.
According to a recent study, millennials carry an average of $48,611 in debt.1 And our recent survey found that mounting debt is the second leading source of financial stress for millennials.2
While some debt, like mortgages or student loans, are often inevitable, others like credit cards and high-rate loans, could make achieving your financial goals harder.
The sooner you pay off your debt, the more money you may have available to put toward savings or investments. A powerful tool in your debt payoff arsenal is the debt avalanche method, which prioritizes paying off the highest rate debts first.
Let’s dive into how this method works and what makes it effective.
Key Takeaways
The debt avalanche method may help you save money by prioritizing paying off high-rate debts first.
The method may be a smart choice if you want to reduce your interest costs, even though it may take longer to pay off your first debt.
There are other debt payoff strategies like the debt snowball method, debt consolidation, or balance transfers that could be effective alternatives to the debt avalanche method.
What Is the Debt Avalanche Method?
The debt avalanche method is a debt repayment strategy that prioritizes paying off the debts with the highest rate, expressed as Annual Percentage Rate (APR), first. By targeting high-rate debts, you may reduce the amount paid in interest and accelerate progress towards reducing your overall debt.
The avalanche method aims to empower you to make strategic decisions about your debt and potentially save money in the long run.
Which Debts Are Suited to the Debt Avalanche Strategy?
The debt avalanche method works for many debt types, like personal loans, car loans, or credit cards, but it’s less effective for mortgages. Mortgages often carry lower rates, longer terms, and high(er) balances, so they’re best to be considered separately from other debts when evaluating a payoff strategy.
How to Implement the Debt Avalanche Method
If you’re looking to implement the debt avalanche method, try using the following steps.
Step 1: List Your Debts
Gather all the necessary information about the debts you’re looking to pay off, such as credit cards, loans, and even medical bills.
Make a comprehensive list that includes each debt, the rates you’re paying, and the minimum payments required to help you identify which debt to pay off first.
Step 2: Create a Budget
Calculate how much you can allocate towards your debt payments while still meeting your essential expenses and savings goals. To do so, it may help to create a budget to organize where your money needs to go.
Minimum payments on existing debt balances must be maintained even if you are targeting one debt in particular to pay off. Missing any payments along the way could hurt your credit and potentially cost you fees, both of which would be counterproductive!
When budgeting, if you find that you don’t have enough money to meet all of your minimum payments and make a larger payment on your top-priority debt, it’s probably time to tighten your belt a bit. You may want to try tracking your expenses to see if there are any areas where you could reduce spending and reallocate those funds toward paying off debt.
Step 3: Focus on the Highest-Rate Debt
Once you have your funds earmarked, it’s time to get to work. Identify the highest rate debt, and each month, pay more than the minimum payment until it’s fully paid off.
Step 4: Reallocate Funds to the Next Highest-Rate Debt
After you pay off the highest rate debt completely, move on to the one with the next highest rate.
With each payoff, a minimum payment obligation is eliminated. Therefore, you should find that you have more funds available for payment with each subsequent effort!
Debt Avalanche 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 a rate of 20.00% APR, balance of $15,000, and a minimum payment of $200.
Debt C: Car loan with a 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 has 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’s fully paid off.
Once Debt A is paid off, you would direct the funds that were previously allocated to it towards Debt B, making the monthly payment for Debt B $650.
After paying off Debt B, you would focus on Debt C, using the entire $800 each month.
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, regardless of rate.
Let's take a look at the pros and cons of each method.
Method | Pros | Cons | Best for |
|---|---|---|---|
Debt Avalanche | May reduce total interest paid by tackling highest-rate debt first | May take longer to pay off first debt if it’s also the largest balance | People who prioritize saving money and want to minimize interest costs |
Debt Snowball | Potentially easier to implement by starting with the smallest debt | May take longer to pay off debts if highest-rate debts are the last to be paid off (and more interest accrues) | 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. 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. Here are two additional approaches that could help you pay off debt.
Debt Consolidation Loan: If you have multiple high-rate 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: This method lets you transfer your debt to a credit card with a lower APR than your original debt. These lower rates typically last for a specific period, giving you time to pay off what you owe. This may provide temporary relief from a higher rate. However, it's important to be mindful of the terms and fees associated with balance transfers, as they may create a cycle of debt if not managed carefully. Additionally, once the promo period ends, the card’s regular rate kicks in, which could be costly if you haven’t paid off the transferred balance.
As you embark on your debt repayment journey, consider reaching out to financial professionals or credit counselors who could 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-rate 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 building greater financial security.