Debt Avalanche: Accelerated Repayment Strategy Explained

What Is a Debt Avalanche?

The debt avalanche is a debt repayment plan focused on paying off debts with the highest interest rates first, helping you save money on interest over time. It is often considered more cost-effective than other methods because it minimizes total interest paid, eliminating debt faster. Unlike the debt snowball method, which prioritizes smaller balances, the avalanche method targets financial efficiency. In this article, we explain how the strategy works along with the pros and cons to help you decide if it’s the right approach for your debt management strategy.

Understanding the Mechanics of a Debt Avalanche

Paying off your debts can be a daunting task, especially when you're faced with multiple debts, high balances, and sky-high interest rates. Making only the minimum monthly payments can make the process feel even more overwhelming, as the majority of your payments go toward interest rather than the principal balance.

This is why it's important to have a strategy in place that will help you become debt-free. The debt avalanche is one such strategy. This method allows you to concentrate on the debts with the highest rates first. You can then target the one with the second-highest rate, and so on and so forth, until you're left with the debt that charges the lowest rate.

The debt avalanche allows you to focus on lowering the debt you have by paying less interest over time. Here's how you should structure this repayment plan:

1. The first step in starting a debt avalanche strategy is to make a list of all the debts you owe along with the individual interest rate for each.
2. Next, designate an amount of your available monthly income for repaying debts. This amount should come from any funds not currently obligated for living and household expenses like rent, grocery, child care, or transportation. 
3. Make a lump-sum payment (above the minimum required payment) to the debt with the highest interest rate. Ensure that the payment is significant but within your means.
4. Continue making minimum payments on your other obligations until the highest debt is paid off.
5. Move on to the debt with the next highest interest rate. Repeat until all of your debts are clear.

This strategy takes time, so it's important to be patient and not lose your focus.

Pros and Cons of the Debt Avalanche Method

Advantages of Debt Avalanches

The debt avalanche method helps you pay less interest over time because it targets high-interest debts first. Most lenders use compound interest, which means the more often it compounds, the more interest you pay.

A debt avalanche repayment strategy also reduces the amount of time it will take you to get out of debt—assuming you make consistent payments—because less interest can accumulate.

Disadvantages of Debt Avalanches

One of the main disadvantages of using the debt avalanche as a repayment strategy is that it only targets interest rates rather than balances. As such, you may not necessarily put a dent in the debt with the highest balance as it only receives the minimum payment. This can be daunting and cause you to feel like you're not making any progress.

The debt avalanche method requires discipline for consistency, which can be a downside for some people. Even with the best intentions of sticking with the debt avalanche strategy, you may revert to making minimum payments on all of your the debts, especially if your financial situation changes. That’s why most financial planners recommend to first save up a six-month emergency fund before attempting any accelerated debt payoff plan.

Comparing Debt Avalanche With Debt Snowball Strategies

The debt avalanche is different from the debt snowball. This is another accelerated debt payoff plan that requires a focused, dedicated approach.

With the debt snowball strategy, the debtor uses money beyond the minimum payments to pay off the debt with the lowest balance first before moving on to the one with the next-smallest outstanding balance, until you eventually reach the one with the highest balance. As with the debt avalanche, you must continue making the minimum payments on your other debts while repaying the smallest one.

The debt snowball doesn't save as much interest as the debt avalanche, but it can keep you motivated by letting you quickly knock out small debts.

Example of Implementing a Debt Avalanche

Here's a hypothetical example to show how a debt avalanche works. Let's imagine you have $500 available every month (after you factor in your living expenses) to put toward paying down your debt. Say your current loans include:

• $1,000 on a credit card with a 26% annual percentage rate (APR)
• $1,250 on a personal loan with a 12% APR
• $5,000 line of credit (LOC) with an 8% interest rate

Assume each debt has a $50 minimum monthly payment. You'd pay $150 total for these minimums ($50 x 3). Then, you'd pay the extra $350 toward your highest-interest debt, the credit card. Once that's cleared, you’d focus the extra money on the personal loan, and eventually, use all $500 for the LOC, which has the lowest interest rate.

The Bottom Line

The debt avalanche method targets high-interest balances first, helping you save the most money on interest over time. The debt snowball method, on the other hand, focuses on paying off the smallest balances first, offering quick wins that can give you a motivational boost. Choosing between the two depends on your financial situation, discipline, and goals. If you have significant debt, you may also benefit from professional financial advice to determine which strategy can help you in the long run.