- Making a plan to reduce debt is an important goal, and it makes sense to find a strategy that works best for your finances and your motivation.
- The debt avalanche method proposes tackling debt with the highest interest rate first.
- Knocking out debts can save considerable money, but it may take time to see progress.
You may have heard about the debt avalanche method, but be unfamiliar with how it works and why it may or may not be right for your debt-repayment goals. Here are some of the fundamentals you need to know.
Before you reduce your debt, there are a few basics you should be aware of. To start erasing debt, take note of the following:
1. Stop adding new debt
If you’re trying to clear a path toward becoming debt-free, taking on new debt will sabotage your efforts. You can’t pay off a balance if you’re continuously adding to it, so be sure to spend within your means. Place limits on yourself and keep yourself in check by looking for a friend or consultant who can help hold you accountable.
2. Pay on time
Before dedicating added resources to pay off debt, it’s essential to ensure that you can continue making on-time payments for necessary expenses and existing priorities. Being a responsible account holder can lift and maintain your credit record and show that you’re a trustworthy borrower.
3. Pay more than the minimum
Prioritizing debt repayment is an important goal, but you need to consider making room in your budget. To cover your debt, make sure that: 1) your everyday living expenses are adequately covered; 2) additional money is available over and above what you typically spend; and 3) you won’t be breaking your monthly budget while chipping away at debt.
What is the Debt Avalanche Method?
When you’re carrying multiple debts at once, it can be hard to know how to prioritize repayments. The debt avalanche method is a strategy that concentrates on reducing your highest-cost debt first.
To use the debt avalanche method, make a list of your debts by the interest rate they charge, from highest to lowest. For example, your highest interest rate might be associated with credit card accounts, while your lowest may be a student loan or car loan.
As you pay at least the minimum amount owed on all your outstanding debts, you’ll direct money you can spare on debt with the highest interest rate. Once you've paid off your balance, you’ll move on to the next highest interest rate debt on your list — and repeat the process until you work your way down the debt mountain.
For example, let’s say you have a $10,000 credit card balance with an 18.99% annual percentage rate, a $15,000 personal loan charging 8% interest and a $5,000 car loan with a 2.8% interest rate. To start:
- Put the credit card debt at the top of your list.
- Aim to devote an additional $200 a month on top of your $200 monthly minimum payment. By doing so, you’ll pay off your credit card debt five years and eight months faster and save $7,140 in interest charges.
- Once the credit card — or highest interest rate — debt is paid off, apply $400 (the $200 additional plus the $200 minimum from the credit card) to the minimum monthly payment of the next debt on your list.
You can use a debt avalanche calculator to input your own numbers and figure out how much time and money you can save.
Benefits of Using the Debt Avalanche Method
Prioritizing the repayment of debt with the highest interest rate has the potential to save you considerable money on the amount of costly interest you pay.
What’s more, by accelerating the amount you put toward debt, you’ll also be shortening the time frame for payoff. The bottom line? You’re minimizing the total cost of borrowing in the long run.
Drawbacks of Using the Debt Avalanche Method
The debt avalanche method means being okay with delayed gratification, because it may take longer to pay higher interest debt off first compared to debts with lower balances. This may matter if your highest-cost debt is also the largest because there will be a time-lapse before you settle your debt and move on to the next. Ultimately, it might not feel like you’re making progress very quickly, especially if you have limited financial flexibility.
The amount saved by paying off high-interest debt first can also vary depending on the types of debts, amounts owed and interest rates. In the long run, however, the debt avalanche method can help you have more money.
When Debt Avalanche May Be a Good Idea
There are two things that can make the debt avalanche method more beneficial than other methods. First, if you have one or more debts with a very high interest rate, the savings you’ll gain from the debt avalanche method may be substantial. Likewise, if you have a large amount of debt, your interest savings by using the debt avalanche may be significant.
Finding a Debt Reduction Tactic
It's important to find a debt repayment strategy that works for you and your finances, and the debt avalanche is only one method to consider. Ultimately, you’ll want to create a plan that feels suitable for you so you can channel your resources and make the biggest impact on what you owe. Your best choice may be a mix of math and motivation.
Want to learn about another type of debt-reduction strategy? Discover how the debt snowball method can knock out debts and deliver some quick wins.