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What Is the Debt Avalanche Strategy And How Does It Work?

What Is the Debt Avalanche Strategy And How Does It Work

What is the debt avalanche strategy? The debt avalanche strategy is the method of debt payoff starting with the loan that has the highest interest rate. After that, you move on to the loan with the next highest interest rate.

The major focus of the avalanche debt repayment method is to reduce the amount of interest you incur and this will help you pay off your debts in the long run. Maybe even faster than the other strategies – depends on your attitude towards it.

Here’s How the Debt Avalanche Works

To get started with the debt avalanche strategy, here are ways to save on interest.

Take inventory of your current debts. List out your debts. Highlight them in order of interest. The one with the highest interest rate should be on top while the lowest falls beneath.

Pay the minimum amounts. Clear out the minimum payments on your credit card balances and loans. Do it one after the other, but ensure to stay current with the rest so as not to have compiled heavy fees that may badly affect your credit score.

Make an additional payment on interests with the highest rate. Plan extra payment for any available money you have each month to reduce the highest interest gradually.

Build momentum. After you have cleared a loan, strike it out and redirect the cash going into it to the next loan with the next highest interest rate.

Use a spreadsheet to estimate your debt avalanche pay-off schedule. You can use a loan calculator to estimate your interest rates till you finalize a card or loan repayment.

If for instance, you owe money on the loans illustrated below. Based on your monthly budget, there is an additional $150 left each month for clearing out debt. Which loan would you consider first?

Follow the example given below. Enlist your loans with the one with the highest interest rate on top.

Debts to Pay Off

Type    Balance    Rate    Minimum   Payment

Credit card    $16,000     17%     $480.00

Personal loan    $2,000     7%      $39.60

Private student loan   $13,000    5%    $183.74

Auto loan       $21,559      4.75%      $404.38

Medical office    $1,300      0%           $100

 

Using the debt avalanche method, the extra cash of $150 is used for the credit payment since it carried the biggest interest rate. So, you’ll have to pay $630 which is the $150 additional monthly payment and the $480 minimum payment.

Once the credit card balance is paid, the minimum payment is cleared and more cash flow will be accessible each month. So, the $630 amount that was being separated for credit card companies is now readily available for personal loan repayment. In essence, the sum of $669.60 which is the required $39.60 and $630 will be paid to eliminate the remaining loan balance.

Thereafter, input your payment on the personal loan to the extra payment resulting in an extra monthly payment of $669 on a student loan. The loan servicer will hence receive a total amount of $853.34 which is the sum of the required $183.74 and $669.60. You’ll keep on with this procedure till you finally become debt-free.

 

Why You Should Consider the Debt Avalanche Strategy

The debt avalanche has a lot of benefits to your finances. Since its major focus is on interest rates, it is very effective in helping you attain a debt-free life. Most loans have a part of the monthly payment being directed into interest charges while the rest are used to cut down the loan balance. 

And when the interest rates are high, you will have to make more payments to newt up the cost of interest, and your payment may not make a significant mark on the actual balance of your loan. So, when you’re able to reduce the overall interest rate of your loan, you would have successfully reduced the amount wasted paying the extra interest.

 

Do I Need to Use the Debt Avalanche Strategy?

The debt avalanche strategy is a good consideration for a variety of reasons. 

  • You may want to reduce your total borrowing cost.
  • You may be self-disciplined to pay extra on a sizable debt for a period without paying it off quickly satisfactorily.
  • You don’t necessarily need motivation as a positive reinforcement in keeping up with your debt-free plan.
  • You believe in paying reduced interests as you can.

 

Debt Avalanche Strategy vs. Debt Snowball

While the debt avalanche focuses on paying debt starting from the one with the highest interest rate, the debt snowball starts with the one with the lowest balance.

The avalanche strategy provides reduced cost in the long term but the snowball method may have higher interest with small ‘wins’ as you clear out your balances. 

The debt avalanche strategy is a considerable option if you want to tackle your debt by reducing accumulated interest rates, but It doesn’t work the same for everyone. The debt snowball strategy is an alternative where you repay debts in their sizes, starting from the lowest first, and to the highest. 

The debt snowball strategy helps to keep you motivated with small wins as you gradually make your way to becoming fully debt-free. The odd side is that you may end up paying more with this method in terms of interests.

So, if you’d like to walk through debt repayment by staying motivated, then think of the debt snowball strategy. But with the debt avalanche strategy, you have to be self-disciplined and trust that paying from loans with the highest interest rates matters, though might take a long to finally clear off.

So, with the earlier example, the debt avalanche would require that you delay the medical debt as it is interest-free. But the snowball strategy would demand that you begin with it since it has the smallest balance. And after paying it off, you’ll move to the next smallest loan balance on the list.

 

What to Do If You Need Help With The Best Avalanche Strategy 

While some borrowers will find the debt avalanche strategy very helpful, others may need some help with it.

Debt settlement

This option may seem a bit extreme. With this, you’ll attempt to pay loan providers less than the actual amount of your loan with support from a for-profit company. However, it is not likely that your lender will want to negotiate. In addition, debt settlement programs can result in a drop in credit scores. So, it is often advised that you consider the other option first before this.

 

Credit Counseling

You may be having a hard time making your debt repayment with no extra funds to put in the debt avalanche, why not seek help?

Credit counseling agencies are nonprofits, and they can be helpful in getting you to take charge of your debt by providing relevant guidance and education. A debt management plan (CMP) might be set up to provide relief in reduced rates and monthly payments.

You may be charged a fair sum for having them manage your debt.

In conclusion, if you’d like to minimize interest rates, then consider the debt avalanche strategy. And if you are having a tough time paying the minimum payment, then you should consider a nonprofit credit counseling agency and go for debt settlement as a final resort.

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