Getting out of debt is rarely easy — it can take a lot of hard work and determination. But it’s possible, even if you have a lot of debt.
According to the Federal Reserve Bank of New York, American household debt balances, which include mortgages, auto loans, credit cards, student loans, and more, were nearly $500 billion higher in the first quarter of 2021 compared with the end of 2019. This is a staggering number and having the debt spread out might make it harder to focus on where to get started.
But with a simple strategy, such as the debt avalanche method, you could be on your way to tackling your debt and paying it off. See how the debt avalanche method works and whether it’s the right choice for you and your personal finance goals.
What is a debt avalanche?
A debt avalanche is a debt repayment strategy. It is a plan for helping you reduce your debt and hopefully pay it off completely. Debt repayment plans can be useful resources for learning how to pay off debt.
This strategy focuses on first paying off your debt with the highest interest rate, sometimes called the APR, and then moving onto the debt with the next highest interest rate. This doesn’t mean you completely ignore your other debts. Rather, you make the minimum monthly payments across all debts and then put extra funds toward the debt with the highest interest rate.
When credit card balances or loans have high interest rates, it can feel as though you’ll never get out of debt. This is because the interest is growing so fast that making a minimum payment could equate to just paying off the interest each month instead of the money you borrowed.
The purpose of this strategy is to reduce the overall amount of interest you pay, and therefore the total amount it takes to pay off your debt. By tackling the highest-interest debt first, you end up paying less on your total debt in the long run.
The debt avalanche method can be used for virtually any type of debt that carries interest. Here are a few debt types it could be useful for:
- Car loan
- Student loan
- Credit card debt
- Medical bills
- Personal loan
- Payday loan
- Home equity line of credit (HELOC)
How does a debt avalanche work?
The debt avalanche method is easy to understand. “Simply find out which of your debt has the highest APR and start paying that balance down to $0,” says Adem Selita, CEO and co-founder at The Debt Relief Company. “You will then go to the next highest APR account and pay that down to zero and so on and so forth.”
But to get started, you have to figure out your budget and how much money you can put toward paying your debt. A best practice for budgeting is to track your total expenses and total income for the month so you can see exactly how much money is coming in and how much is going out. Accessing transactional history in bank accounts or credit card accounts can also be helpful for figuring out your total income and expenses.
Once you know your monthly income and expenses, you should know how much money is available after your necessary bills and expenses to put toward your debts. This money will go toward making the minimum payment on all debts and any extra money will go toward the debt with the highest interest rate.
To know which loan to tackle first, you’ll need to know some relevant information about all your debts. This includes your monthly due dates, interest rates, outstanding balance, and required minimum payments. All this information is typically available on your credit card or loan billing statements, which are often mailed to your home address or available in an online account.
Once you have the information about your debts, make a list of the debt balances and their interest rates. Put the highest interest rate at the top of the list and the lowest interest rate at the bottom. Here’s an example of what your list might look like.
|$15,000 credit card||15%|
|$6,000 personal loan||10%|
|$15,000 student loan||6%|
|$14,000 car loan||4%|
For this example, you would pay the minimum payment on the credit card, personal loan, student loan, and car loan. Then any extra cash left over would go toward the $15,000 credit card debt because it has the highest interest rate. So you would pay the minimum plus your extra money on that credit card.
This process would continue each month until the credit card debt is completely paid off. You would then continue the same strategy, but now the personal loan debt would be at the top of your list and become the focus of your additional payments.
By following this strategy, you should be able to eventually eliminate all your debt and save on interest payments during the process. This would reduce the overall amount you need to pay to eliminate your debt.
Debt avalanche vs. debt snowball
The debt avalanche method is often compared with the debt snowball method, which is another debt repayment strategy. Both of these plans have an end goal of paying off your debt, but they get there in different ways.
A debt avalanche focuses on first paying off debt with the highest interest rate. “The debt snowball method, on the other hand, has you target the debt with the smallest balances first,” says Nathan Grant, a senior credit industry analyst with Credit Card Insider. “When that one is paid off, you move onto the next smallest debt.”
Both strategies have their pros and cons, and each one could fit certain situations better than the other. For example, the debt snowball method could be a good fit if you want the motivation of getting quick wins from paying off your small debts. But if you want to save money, the debt avalanche method likely makes sense because it targets your high-interest debt first and reduces your overall interest charges.
Pros and cons of the debt avalanche
The debt avalanche method can be helpful for paying off debt, but it might not be the right fit for everyone. Here are the pros and cons of this debt repayment method:
- Proven strategy for paying off debt: If you stick to the debt avalanche plan, you should be able to eventually pay off your debt.
- Reduces your overall interest charges: Compared with some repayment plans, such as the debt snowball method, this strategy offers more saving potential on interest charges.
- Simple and easy to understand: Pay off your highest-interest debt first, then the next highest, and so on until you’re out of debt.
- Doesn’t require any paid services: You don’t have to pay any financial services for help with this strategy. You can do it all yourself.
- Could be quicker than debt snowball method: Because you’re paying off your high-interest debt first, you should have lower interest charges overall compared with using the debt snowball method. This could help you pay off your entire debt quicker because less interest means less money paid out overall.
- Won’t work for everyone: If your budget doesn’t allow you to make the minimum payments on your different balances or you don’t have any money left over after making minimum payments, this strategy likely won’t be of any benefit to you. You would have to first find ways to make money so you have some spare cash. Then you can make the minimum payments and also pay extra toward your debt with the highest interest.
- Potentially requires more discipline than the debt snowball method: “With the debt snowball method, you first pay off the debt that has the lowest balance, regardless of the interest rate,” says Zach Reece, a certified public accountant and owner of Colony Roofers. “This can be more motivational for people because they’ll feel empowered when they fully pay off debts one by one.” In comparison, the debt avalanche method starts with your highest-interest debt, which might also be your debt with the highest balance and could take a while to pay off.
What is the best debt payoff method?
Between the debt avalanche and debt snowball strategies, the financially smartest payoff method is likely the debt avalanche. This method is designed to pay off all your debt but focuses on high-interest debt first so you aren’t paying as much interest in the long run.
The debt snowball method can also pay off all your debt, but it focuses on the size of each account balance, paying off the balances from smallest to largest. This potentially lets you pay off some balances quickly, which may give you more motivation to continue paying off your debt.
Overall, the best debt payoff method is the one that keeps you paying down your debt until it’s gone.
What happens if you never pay off debt?
If you never pay off your debt, it could end up being sent to a collection agency. If it’s credit card debt, your account will likely be shut down. Late and missed payments will show up on your credit report and have a negative impact on your credit score. If you continue to ignore your debt, you could be sued, which could lead to your wages being garnished, your bank account being frozen, or a lien being placed on your property.
What is the fastest repayment strategy?
The fastest repayment strategy likely depends on your situation and what you feel comfortable with. The debt avalanche and debt snowball methods can both help you pay off your debt relatively quickly, but the better one for you is the one that keeps you motivated and paying down your debt.
The debt avalanche method is a tried-and-true strategy for paying off debt and it can also help you learn how to manage your money. The strategy makes sense, but it still might not be the right fit for you. If it’s not a good fit, you might consider a paid debt management or debt consolidation plan.
Debt management and debt consolidation aren’t the same thing, but they have the same goal of getting you out of debt.
- Debt consolidation typically involves putting all your debt onto a loan or balance transfer card so it’s in one place and easier to track.
- A debt management plan often includes getting a consultation with a financial advisor or counselor and seeing what your next steps should be, which may also involve consolidating your debt.
Whichever strategy you choose, don’t feel like getting out of debt is impossible. Your dream of being debt-free is real, so don’t give up.