Eliminating debt is the start of becoming financially free. “Financial freedom is having enough income, savings, and investments to support the lifestyle you want to have.” You cannot build these things if you owe more than you save.
Income = cash flow – expenses.
What is the Debt Avalanche Method
The Debt Reduction Avalanche Method is a strategic plan to reduce or pay off debt that follows a strict financial process. The Avalanche Method directs you to pay down your consumer debt with the highest interest rate first. For example, using this method a consumer would review his/her debt accounts according to the interest rate.
He’d rate the debt with the highest interest rate as #1, the second-highest as #2, and so on. In creating this descending interest rate list, you would not take into consideration the amount owed on each account, but rather the interest rate assigned to the debt.
Following this procedure allows you to structure a payment plan that targets and greatly reduces the amount of interest paid over the amount of each loan or debt. Going into this you know that you can reduce the amount of interest paid by as much as 50% over the life of your debt elimination plan.
This is a good psychological foundation to begin your debt repayment journey. After all, in the end, any money you save in interest payments is money you can save or invest for your future.
The Avalanche Method differs from the Snowball Method in that it does not account for the possible emotional and psychological advantages of paying off smaller loans more rapidly. The Avalanche Method looks at the numbers only.
How does the Debt Avalanche Method work?
The Avalanche method works by paying a little extra on your credit account with the highest interest rate. Typically, you would make this extra payment towards the principal amount. You can do this in two ways:
- Pay the minimum balance on all other debt accounts so you can pay more on the #1 account on your Debt Elimination plan.
- Earn more money. Work overtime, find a side hustle, or land a part-time job. Remember you only need to add a little extra to the first pay-off account. This can be any amount from $15-200 dollars.
You should choose a constant amount that you can pay every month regularly. Don’t choose a lofty amount because it sounds good on paper. Keep it manageable.
You should determine how much in total you are spending monthly towards debt elimination. Let’s imagine that amount is $500 per month. After your first debt account is paid off, you do not reduce your monthly spending towards debt elimination and pocket that money. Instead, you should continue your budget as-is and roll over that amount onto debt #2.
When Debt #2 is paid off, roll over everything onto Debt #3 and so on. By the time you get down to your fourth and fifth debt accounts, you will notice how large your monthly payment is towards reducing those accounts. This large payment will help reduce these accounts quicker.
Keep in mind that since you are attacking the debt with the highest interest rate first you may not reach your goal of paying off a bill for a long time. Sometimes, years will pass by before you reach a zero balance.
Avalanche Debt Reduction Example Chart
What are the Benefits of the Avalanche Method
The benefits of the Avalanche method are rooted in purely financial aspects, and they are twofold:
- You pay off your total debt quicker
- You pay less interest on the principal
The Avalanche Method seeks to discount any effect emotion has on the process and focuses solely on the math. The math does not lie, the Avalanche Method is one of the quickest ways to pay off debt and reduce the amount of interest paid.
Some debt counselors don’t approve of the Avalanche Method because it takes a long time to see results. We tend to want results quickly, and when we cannot see them right now, we often lose interest and drop the ball.
Studies on debt elimination strategies show that impatience is often the culprit in derailed debt elimination plans. The Debt Avalanche Method appeals to the logical side of debt reduction and looks solely at the math.
There is no such thing as the perfect debt reduction plan or a one-size-fits-all debt elimination scheme. People in debt must carefully evaluate their desires. If they want to get out of debt as quickly as possible, the Avalanche method is the easiest method to get there. It doesn’t require any more preparation than looking at your current statements.
What are the Cons of the Avalanche Method
One disadvantage of the Avalanche Method is that when compared to other methods, such as the Snowball Method, you typically end up waiting longer for your first debt to be paid off.
Because the Avalanche method doesn’t consider balance or time as a factor in the payment plan, you might find yourself waiting years to pay off a high-interest, high-balance loan.
It has been shown that emotions play a big role in our ability to manage and rehabilitate our spending habits. However, since emotions are usually tied to our purchase decisions, they can easily fail us when we try to repay those obligations.
If the high-interest high-balance debt is paid off first, the debt reduction payment plan can take longer to achieve your first results. No one knows what they’ll feel like a month or two from now.
Waiting for that initial balance to drop to $0 may seem like an eternity.
Conclusion: Who should use the Avalanche Method?
Should you use the debt avalanche method to pay off debt? The short answer is yes. You should use the Avalanche Method to pay off your debt. It is the best way to ensure you are paying as few interest payments as possible.
Your initial goal of paying off at least one debt account may be delayed, and you may have to wait to celebrate a “win” but if you press on and endure the process you will reap rewards much sooner overall.
Paying off debt is a punch to the psychological gut-taxing endeavor but if you focus on going the distance, you’re likely to build psychological momentum.
Once you’ve paid off two to three bills you will have some emotional momentum on your side. If you need to, you can reevaluate your debt-elimination strategy later. But don’t stop the process and don’t slow your progress.
As I said, the key to a sustained debt elimination plan is to adjust and pivot when necessary. It doesn’t matter so much what route you take just so long as you continue moving a little bit forward with each step.
Financial independence isn’t a sprint, it’s a marathon, and the one who holds out until the end wins, regardless of the strategy.
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“Financial freedom is having enough income, savings, and investments to support the lifestyle you want to have.”