The debt avalanche is a method used to pay off debts. It focuses on paying off the loans with the highest interest rates first, then working your way down to the low-interest debts. This can help borrowers save money on interest in the long run by eliminating the most expensive debts first.
What Is the Debt Avalanche?
The debt avalanche is simply a strategy for paying off debt. It can be effective because it focuses specifically on interest rates. With many loans, a portion of each payment goes towards interest, while the rest reduces the principal. And if the rate is high, you need to pay more to cover the interest costs.
How Does the Debt Avalanche Work?
Let’s say you have $1,000 on your credit card with an APR (annual percentage rate) of 20%; a car loan of $1,250 with an interest rate of 6%, and a line of credit worth $5,000 with an interest rate of 8%.
Let’s also assume that you had to pay a minimum of $50 in installments per debt, while your payoff budget is $500. Using the debt avalanche, you would start by chipping away at the highest interest loan, which would be the credit card.
If you were to stick to the debt avalanche program, you would pay $50 each for the car loan and a line of credit. That would leave you with $400 to pay off a portion of the credit card debt every month. By allotting that $400 towards the line of credit debt, you would have it paid off in full within four months. After you clear that balance, you would shift your focus to the second highest interest debt — the line of credit (8%). And when you pay it off entirely, you would switch to the car loan.
Once you clear the outstanding balance on the car loan you would be debt-free, with hundreds of dollars saved thanks to the debt avalanche method.
How Does the Debt Avalanche Differ From the Debt Snowball?
The debt avalanche program is similar to the debt snowball program, another method of repaying multiple loans. The key difference is that by using debt snowball, the borrower focuses the rest of his monthly payoff budget (after covering minimum installments) to clear loans with the smallest balance first. The only advantage of this method is that it gives more motivation to repay all debt, as you will clear the first loan sooner than by using debt avalanche. However, the debt snowball is more expensive than the debt avalanche program in terms of interest charges, as you clear the balance on the most expensive loan last.
What Are the Advantages of the Debt Avalanche Program?
The debt avalanche program has several advantages. It provides a time and cost-efficient way to pay off your debts. You will minimize interest fees while working towards being debt-free. That leaves you with more money in your pocket for other important expenses.
In addition, the debt avalanche can be applied in many situations. The program delivers great results if you have the discipline to keep paying a little extra towards a big debt for a long period, knowing you won’t see any short-term progress. You’ll save lots of money if you have the long-term financial ability to pay off all debts.