What is the Debt Avalanche Method?
An avalanche is more abrupt than a snowball. It occurs when a substantial piece of snow falls because of a weaker layer underneath the large piece fractures and breaks. Gravity makes the large piece of snow move down quickly and become larger as it rolls down the hill.
Debt avalanche is also based on scale. It involves tackling the largest piece and then building momentum with time.
In the debt avalanche method, you continue to make monthly payments on all of your debts. However, as was the case with the debt snowball method, you try to raise extra cash through savings or additional income.
You then use that extra cash to first pay off the debt with the highest interest rate. When that debt is paid off, you then move on to the debt with the second-highest interest rate. You pay that off and continue the process till all your outstanding debt is paid off.
The debt avalanche method is preferred by those borrowers who want to pay lower cumulative interest on their loans. The overall interest cost in the debt avalanche method is lower because it involves tackling the most expensive debt first.
An example of debt avalanche
Let us assume that you have three outstanding loans:
- $1,000 of credit card debt with a 10% APR
- $5,000 of an auto loan with a 15% APR
- $10,000 of a student loan with an 8% APR
So, in this case, you will first use the extra cash to tackle the auto loan. It has the highest APR at 15% and is the most expensive debt.
The amount on the auto loan is higher than that on the credit card debt, but because it is more expensive, you pay it off first. You then move on to credit card debt, and then the student loan.
Tips for Following the Debt Avalanche Method
The debt avalanche method is a debt reduction strategy that focuses on paying off high-interest debts first to minimize the overall interest paid over time. Here are some tips to effectively implement the debt avalanche method:
- List All Debts: Begin by making a comprehensive list of all your outstanding debts, including credit card balances, personal loans, student loans, and any other debts you owe.
- Determine Interest Rates: For each debt, note the interest rate. Arrange the debts in descending order based on their interest rates, with the highest interest rate debt at the top and the lowest at the bottom.
- Make Minimum Payments: Continue making the minimum required payments on all your debts to avoid late fees and penalties.
- Allocate Extra Funds: Identify any additional funds or disposable income you can allocate toward debt repayment. This can come from your budget, side gigs, or windfalls like tax refunds or bonuses.
- Focus on the Highest Interest Debt: Allocate the extra funds you’ve identified toward the debt with the highest interest rate while maintaining the minimum payments on the others. This debt becomes your top priority.
- Pay as Much as Possible: Devote as much money as you can afford each month to the highest interest rate debt. The goal is to pay it off as quickly as possible.
- Monitor Progress: Keep track of your progress as you pay off the high-interest debt. Celebrate your achievements, whether it’s paying off a certain percentage or the entire debt.
- Roll Over Payments: Once you’ve paid off the highest interest rate debt, take the money you were allocating to it (including the minimum payment) and apply it to the next highest interest rate debt on your list.
- Repeat the Process: Continue this process, directing your focus and the extra funds toward the next highest interest rate debt. As you pay off each debt, you have more money to allocate to the next one.
- Snowball Effect: Similar to the debt snowball method, the debt avalanche method creates a “snowball effect” as you clear high-interest debts. The amount you’re applying to each subsequent debt grows larger, expediting the debt payoff process.
- Stay Committed: Consistency and commitment are key to the debt avalanche method’s success. Stick to your plan and resist the urge to accumulate more debt.
- Adjust as Needed: Periodically review your budget and financial situation. Adjust your debt repayment plan as necessary to account for changes in income or expenses.
- Seek Support: Consider joining a support group or finding an accountability partner to help you stay motivated and on track with your debt repayment goals.
The debt avalanche method is an effective strategy for saving money on interest and paying off debt efficiently. However, it may require more discipline and patience compared to the debt snowball method, which focuses on paying off smaller debts first for psychological motivation. Choose the method that aligns best with your financial goals and personal preferences.
What are the key differences between the Snowball vs Avalanche methods?
The biggest difference is cost vs time. The debt snowball method can lead to the clearing your first debt much quicker than would be the case with debt avalanche. You will see your first win much quicker and that would boost your motivation levels for sure.
The debt avalanche method may end up taking more time because your highest interest debt may not be your smallest debt. So, you need more patience and perseverance with debt avalanche.
However, the interest cost with the debt avalanche method is much lower because you get rid of your most expensive debt first.
In the debt snowball method, your most expensive debt could be the last one that you clear and so you end up paying interest for a long time.
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So which method is better?
If you talk about the total time taken to clear all the debts, then there may be some exceptions to these trends.
For example, there could be a scenario where the debt avalanche method helps you pay off your loan a few months before the debt snowball method does. It all depends on your debts, the APRs attached to them, and your cash flow levels.
Another factor to consider is your personality and your mental model.
Are you the type of person that can stick to a plan for a long time even if you do not see immediate results? Or are you someone who needs to see a win, even if it is a small one, to get further motivation to continue with a plan?
So, one method isn’t necessarily better than the other. Studies have also proven this observation. It just depends on what strategy best fits your financial situation and your goals.