Avalanche debt payoff method: Pay off debt faster & save money

Getting out from under debt can free up your budget, reduce stress and increase your financial flexibility. But if you have multiple different debts, how do you tackle them in the most beneficial way possible?

The avalanche debt method is a repayment approach that prioritizes payments with the goal of saving you the most money over time. Read on to learn about this method and how it compares to other debt payment tactics.

The avalanche method prioritizes your payments so that you pay extra on the debt with the highest interest rate. Once it's paid off, you shift to the debt with the next highest interest rate. Repeat this process until all of your debt is repaid.

Here's how to apply the avalanche method for debt:

• Start by ranking your debts from the highest to the lowest rate of interest charged.
• For all debts, continue to make at least the monthly minimum payment.
• Based on your budget, determine how much additional money you could put toward debt each month.
• Put that money toward paying down the balance on the debt with the highest interest rate.

The avalanche method helps you pay down debt by focusing on the debt that's costing you the most money. The goal is to decrease your highest-interest balance faster than other cards and loans that aren't as expensive to maintain. It's a useful method when you have more than one debt and you need a way to prioritize them to organize your debt.

Let's say you have a car loan with a 9% interest rate, a credit card balance at 20% and an appliance store account at 0% for the next 18 months. With the avalanche method, you'd target the credit card first so you could get rid of the highest relative additional charges.

To truly understand the effectiveness, imagine all three balances were $2,000. A rate of 20% interest would add $400 to your credit card balance next month, but your car loan only racks up $180, and the appliances aren't costing you anything in interest right now. Targeting your debts this way tries to get you out from under excessive interest costs the fastest.

The avalanche method is often compared to the debt snowball method. When you snowball debt repayment, you focus on the debt with the lowest balance first, regardless of interest rate. That helps you eliminate a small debt so you can then apply what you would have paid on that to the next smallest debt. The snowball debt method helps you take down your debts one by one while the avalanche method slices off the cliff of interest rates threatening your future.

There are several advantages of tackling debt with the avalanche method. These benefits can help you get ahead and make the most of your payment dollars:

• By paying down the debt with the highest interest rate first, you reduce the total amount of interest you pay over time.
• Because less of your money goes toward interest over time, you can apply more toward paying the principal. This will allow you to pay off your debt more quickly.
• Because you'll spend less on your total borrowing and credit payments, this method is one of the most efficient approaches to debt.

Although the avalanche method makes the most efficient use of your repayment dollars, that doesn't mean it is without drawbacks. There are a couple of reasons that you may not want to follow this approach:

• The debt with the highest interest also may be a high-balance debt. While the avalanche method steadily reduces your total charges by chipping away at the high-interest balance, it may be a while before you can tell you're making a dent. If you thrive on quick results, the snowball method may be a better option.
• It also can be the case that your highest-interest debt isn't the debt with the biggest balance. While you're focusing on high rates, you may be putting off debt that has a higher running total. This can leave you feeling like you're not making progress bringing down the total balance of your debts.

Let's take a look at the debt avalanche method in action. Suppose you have the following debts, each with a five-year repayment term. You have an extra $500 per month you could use toward paying off debt.

Your total minimum monthly payment across all three debts is $704.24. If you paid that amount each month you would end up paying a total of $42,254.40 over five years.

If you use the debt avalanche method, you would apply that extra $500 per month toward the credit card, for a total payment of $897.41. You would pay it off in 20 months, which would free up that $897.41 to pay elsewhere. You would then apply that toward the car loan since it has the next highest rate, bringing your total payment on that loan up to $1,109.88. It would then take an additional seven months to pay that off.

After 27 months of making the minimum payment, you'd still owe $2,903.53 on your personal loan. Add the $1,109.88 to your minimum payment, bringing the total to $1,204.24. With the avalanche debt approach, you could be debt-free in three months.

The total amount paid with the avalanche method is a little less than $36,000. You will have saved more than $6,000 in interest and repaid your debt in half the time.