A debt avalanche is the process of paying off your loans starting with the highest interest rate and making your way down to paying off your debts with the lowest interest rates. Typically, with a debt avalanche, the balance isn’t considered; the method only takes interest rates into account. The process requires you to pay the minimum amount of payment for each debt except the one with the highest interest rate. With the highest interest debt, you prioritize it by paying over the minimum amount. Since interest rates over time can drain your wallet, going through with a debt avalanche might be the financially smart route to go. When in doubt, leverage the advice of a trusted financial advisor.
In order to know if a debt avalanche is right for you, we’ve put together a guide that covers the basics. Read on to learn more about what you need to consider when it comes to paying off debts this way. Make sure to not only determine how long it would take for you to pay off your debts, but also how you are personally motivated to make your decision.
What is a Debt Avalanche?
A debt avalanche is a system of paying off debts starting with your highest-interest-debt first. Since this can be tricky to understand, the table below gives you an example of how the process works. Mentioned are the types of loans, costs of the loans, and overall interest rates.
In this specific example, with a debt avalanche, the only column looked at is the interest rate. Since a debt avalanche starts with paying off your highest interest rates, the personal loan is the first one to pay off, at 18.2 percent. In order to speed up the process of paying the larger interest rate, you make the minimum payment for all other loans (credit card bill, student loans), and put all other disposable income into your personal loan (the highest interest rate).
Then, after completion, the next loan to pay off is the credit card bill, at 14.08 percent. Lastly, student loans. Even though it’s the highest bill, the interest rate for student loans is the lowest and the last to be paid off at 5.8 percent. With a debt avalanche, you pay the monthly minimum amount on the loans that you aren’t focusing on, and pay the highest possible amount on the loan that you are focusing on.
Debt avalanche, just like other alternatives, has drawbacks and benefits that you should consider. Most have to do with it not necessarily being immediately rewarding – it is very practical. If your debt that has the highest interest rates will take you 30 years to pay off, it might not be the best idea to pay only the minimum until you pay it off. That being said, this process could be best for people who are encouraged by paying the least amount of interest. If you want to overcome your debt that is taking up the highest interest rate out of your budget, then this may be the route for you.
Debt Avalanche Benefits
The pros of a debt avalanche center around the fact that it increases the amount saved in the long run, and decreases the time you spend paying off debt. If you’re someone who’s financially motivated, these are some of the benefits of this route.
- Paying off higher interest rates allows you to incur fewer rate periods over time, meaning that you are paying less money in the end. The longer you are exposed to higher rates, the more money you are paying over time. Therefore, paying more than the minimum amount for the larger interest rate is the economical option.
- When putting more money into the larger interest rate debt, you shorten the amount of time that you’re in debt. The faster you pay off the larger interest rate, the less time you spend paying that debt.
Debt Avalanche Drawbacks
Although there are benefits, the drawbacks of the debt avalanche route should be considered as well. Since the method is solely focusing on the interest rate, other factors aren’t taken into account — something that can be a problem for people in debt. The main two drawbacks are listed below.
- A debt avalanche doesn’t give you much positive reinforcement since it takes a longer time to pay off. When tackling large interest rates, the amount you owe can be illogical to pay off first if it takes several years. This can be discouraging to people that feel a sense of relief when constantly checking off something on their list.
- Since a debt avalanche doesn’t consider your minimum payment amount, it might be unrealistic for some people to prioritize the higher interest rate. If you can’t afford to pay more than the required minimum payments across all debt accounts, then you might not have the financial means to pay off your highest interest rate loan. If this is the scenario, it might be best to consider other options.
Is Debt Avalanche Right for You?
The first step of knowing if a debt avalanche could be right for you is determining if you’re in a steady financial situation. If you are able to pay your minimum payments and still have leftover money to put towards the debt with the highest interest rate, the process might be a helpful choice.
Another main point in determining whether or not to avalanche your debts is to think about what your future finances are going to be like. If you’re unsure about your future financial stability, it may be best to just pay the minimum amount on all your debts in order to keep extra cash for later.
Alternatives to Debt Avalanche
Debt avalanche isn’t the only route you can take. Try and weigh out options in order to best navigate your financial journey. When weighing your options, consider your current and future salary, years it’ll take to pay off your largest debt, and how you’re personally driven when it comes to finances. If you realize that debt avalanche isn’t a practical way of getting rid of your debts, you might want to look at these options:
Debt Avalanche vs. Debt Snowball
What makes a debt snowball different than a debt avalanche is that it prioritizes the small loan amount. You pay the minimum amount to each loan other than the one with the smallest amount, and put more money towards the smallest debt. The momentum and drive of checking loans off of your budget checklist might give you the motivation to pay off the larger amounts in the future. Unlike a debt avalanche, a debt snowball doesn’t look at interest rates; it only looks at the total amount of the loan.
Debt Avalanche vs. Debt Snowflake
Unlike a debt avalanche, debt snowflake is a method of earning money to put towards paying off your debts. With debt snowflake, you find small ways to save money and cut back costs in order to directly use the money saved on your loans. This can include reducing the amount you spend, or finding ways to earn extra money.
Whichever way, the more you have in your bank account, the more you can put toward paying off your debts. From selling clothes that you no longer need, to making sure you only delegate a small portion of your salary to eating at restaurants, debt snowflake can be used alongside any other methods of paying off your debts.
Common Questions About Debt Avalanche
It’s likely you have a lot of questions about the debt avalanche method. We’ve addressed a few of the most common ones below:
- Is It More Expensive to Debt Avalanche or Debt Snowball? Debt snowball typically is a more expensive route. Paying off the smaller debt may lead to incurring more interest over time, since debt with higher interest rates can be accumulating and adding up.
- Should I Pay Off my Lowest Balance or Highest Interest? You may want to pay off your lowest balance first if you are someone who needs constant small victories, since this will keep you motivated to pay off your loans. However, getting rid of your highest interest loans is the money-smart way to go. It saves you time and money by tackling the bigger loans with large interest rates.
Different debt processes work for different people. The direction you choose can depend on your income, motivations, and overall expenses. By doing your research and weighing the pros and cons, you can find the route that works best for you. With debt avalanche, you are choosing the quicker and financially smart alternative. Although this sounds like a win-win situation, it may not be the best practice for people who need to constantly be motivated with small achievements. Regardless, your financial journey isn’t black and white. Through research, you can find the method that best fits your needs.