The debt avalanche is an accelerated debt repayment strategy whereby the debtor allocates sufficient funds in order to repay the minimum amounts to each of their debts, then any remaining funds are assigned to the debt with the highest interest rate.
This is different to the snowball method of debt reduction.
Using this strategy when the debt with the highest interest rate is finalised the funds that were allocated to that debt are then put towards the next highest interest rate debt
This cycle continues until all the debtors’ debts are all completely paid off.
What is the the Debt Avalanche Method
Tip: It is important to note here that in order to be successful you should ensure you have enough money set aside in in case of emergencies and are able to cover your living expenses.
To start your debt avalanche strategy, you will need to assign an amount of your income (monthly is ideal period especially if you have more than 1 source of income) after taking into account your obligated expenses for living such as rent, groceries, transport etc, then work out how much you have available to allocate towards debt.
As an example, say you have $600 available each month after expenses that you can put towards reducing your debt.
You currently have these debts monthly:
- $1000 on a credit card with a 21% interest rate
- $1300 car repayment at a 6.5% interest rate
- $7000 personal loan at an 8% interest rate
For the purpose of this example let’s assume the minimum monthly repayments on each debt, except the car loan is $50 per month.
So you would allocate $100 towards paying each loans monthly repayment and the remaining $500 would be devoted to paying the highest interest rate loan – the credit card.
Using this calculation, the credit card would be paid off in 2 months, assuming you didn’t add any extra charges to the card during the 2 months, now the $500 can be put towards the next highest interest rate debt which in this instance is the personal loan, with the car repayment being the last to finally be paid.
While the advantage of the avalanche strategy reduces the amount of interest you pay, it does require a lot of discipline, and will only work if you stick to the plan.
Assuming your repayments are consistent it will also lessen the amount of time it will take you to get out of debt, as there is less accumulation of interest.
Leander’s use a method called compound interest; this increases your debts substantially, the rate of which depends on the frequency of compounding, the higher the number of compounding periods the greater the compound interest.
For example, most credit cards will accrue compound interest on a daily basis, whereas some loans the interest is compounded monthly, semi-annually or annually.
The disadvantage of the debt avalanche strategy for many people is the discipline and commitment required to pull this type of debt repayment strategy off.
Even with the best intentions, you are not in control of unforeseen emergencies that happen in life, such as a car breaking down, medical issues or home repairs, circumstances like this will often have us reverting back to making only the minimum repayments in order to deal with the situation.
Financial planners (Tip above) suggest that anyone attempting to use the avalanche strategy have a fund set up to cover emergencies, 6 months’ worth of expenses is ideal.
The avalanches strategy is not for everyone, as mentioned, this method takes a great deal of discipline to make it work, using this method means having enough money for all your living expenses and money put aside for emergencies.
Having said that if you can stay the course using the avalanche strategy as a systematic way to erase debt fast, you will be able to get out of debt relatively cheaply and expeditiously.