The Debt Avalanche Method: How It Works And How To Use It

If you feel buried by an avalanche of debt, something known as the debt avalanche method may come to the rescue Via @ForbesAdvisor

7/31/2021 11:55:00 PM

If you feel buried by an avalanche of debt, something known as the debt avalanche method may come to the rescue Via ForbesAdvisor

If you feel buried by an avalanche of debt, something known as the debt avalanche method may come to the rescue. The debt avalanche method is a strategy for paying down debt. It involves concentrating on paying off your highest-interest debt first, followed by the debt with the next highest interest rate and so on. […]

$330In this scenario, you’d focus first on the credit card with the 18.99% APR. If you have an extra $100 a month to put toward debt repayment, you will combine the minimum monthly payment of $120 with the $100 in extra money for a total monthly payment of $220. You’d make that $220 payment each month until the credit card balance goes to zero.

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Once you fully pay off the credit card with the 18.99% APR, you’d move on to the 10.99% APR personal loan. You’d combine the $220 a month you had paid toward your credit card debt with the $200 minimum monthly payment for the personal loan, putting a total monthly payment of $420 toward the personal loan.

After you’ve paid off the personal loan debt, you’d repeat the debt avalanche process and move on to the student loan with the 4.99% APR, paying $420 on top of the student loan’s $400 minimum monthly payment. Finally, you’d work on paying off the auto loan with the 2.99% APR. As a reminder, you’d always make at least the minimum monthly payment on all of your lower-interest debts while targeting the highest-interest debt.

Advantages and Disadvantages of Debt AvalancheOne of the main advantages of embracing the debt avalanche strategy is that you’re chipping away at the highest-interest debt before any other debt. In the long run, this could save you a considerable sum of money in the form of interest charges.

Furthermore, the debt avalanche strategy may provide some motivation because you’re getting rid of the highest-interest, most costly debt first. Also, the debt avalanche could be a shorter route to debt-free status than other repayment strategies, because you’ll pay less in interest overall.

However, the debt avalanche method may be disappointing because the highest-interest debt may also be the debt with the highest balance. If that’s the case, it may take a while to see progress and it may be challenging to stick to the strategy.Research published in 2018 concludes that the debt avalanche method doesn’t offer “significant psychological benefits,” which factors into

comparing the debt avalanchewith the alternative debt snowball method. However, the report adds that “if the goal is for the individual consumer to simply pay off their debts the most quickly, and the consumer has no motivational or habitual issues that might complicate this, the avalanche…will nearly always be the superior choice.”

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Is the Debt Avalanche for You?If you’re interested in paying off your high-interest debt first and also self-disciplined and self-motivated, the debt avalanche method may be right for you. Why? Because this strategy knocks off high-interest debt piece by piece and can save you money in interest charges, yet it requires patience to carry out—it could take some time to pay off your initial high-interest debt, depending on the size of the balance.

Debt Avalanche AlternativesIf the debt avalanche method doesn’t suit you, there are several other debt relief options. Here are five of them:Debt snowball.debt snowball methodrelies on tackling the smallest of all your debts first, followed by the next smallest debt and so forth. Using the example above, under the debt snowball strategy, you’d concentrate on erasing the $5,000 in personal loan debt before the $6,000 in credit card debt. But, as with the debt avalanche method, you’d still shift to the second debt all the money you had assigned to the first debt. So, if you adopted the debt snowball method and had been paying $300 (the minimum plus your extra $100) a month toward the $5,000 in personal loan debt, you’d add that $300 to your $120 minimum monthly payment for the $6,000 in credit card debt.

Debt snowflake.The loosely structured debt snowflake approach is simple: You group relatively small amounts of money and put the total toward paying off your debts. So, let’s say you one day find a $5 bill while walking in your neighborhood park and you save $2.50 on a product using a store coupon. You’d allocate this $7.50 toward debt reduction. Unfortunately, it may take much longer to pay off a credit card balance of $6,000 if you’re embracing only the debt snowflake method for debt reduction.

Debt consolidation loan.Combining many or all of your debts into a single loan with a single monthly payment can help you get a better handle on unloading your debt. And, if you do it right, you may end up paying an interest rate on the single loan that’s lower than the combined interest rate for your various debts. On top of that, you may get rid of your debt more quickly than you otherwise would have. Yet

debt consolidationmay give you the false sense that you can spend more money and may not fix any of your underlying financial issues. Also, you could be hit with fees when you take out a debt consolidation loan and pay even more in interest over the life of the loan.

Debt management.let you make a single monthly payment to cover your unsecured debts, allowing you to potentially simplify the payment process and get out of debt more quickly. Nonprofit consumer credit counseling agencies generally offer the best debt management plans.

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Debt settlement.Debt settlementis a form of debt relief that involves negotiating with creditors to pay off your existing debt at a lower amount than what you owe, typically in one lump sum. Whether you do this on your own or hire a company, it comes with significant risks and is often seen as an option of last resort. It’s important to know the pros and cons of debt settlement before choosing it as a debt relief option.

Bottom LineWhether you choose the debt avalanche method or another form of debt reduction, the debt relief method that’s best for you is the one you’ll stick with until your debt is eliminated, or at least under control. Since it targets your high-interest debt first, effectively reducing the overall amount you’ll pay in interest, the debt avalanche method works for some. Before choosing a debt relief method, compare options and choose the one that best fits your situation.

Find Out If You Qualify For Debt Relief Read more: Forbes »

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