Last Updated on January 5, 2021 by Emma @ Making and Saving Money
The debt avalanche strategy is a debt repayment method that sees you paying the minimum interest charges possible, by focussing on your debts with the highest interest rate first. At the same time, you make the minimum monthly payment on your other accounts.
Is the debt avalanche method the right debt repayment approach for you?
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The debt avalanche method – highest interest rate first
The debt avalanche involves paying off debt with the highest interest rates first (the highest APR) and the lowest interest rate (APR) last. Using the debt avalanche method to become debt-free will minimise the amount of interest you will incur as you pay off debt. As you focus on repaying your highest-interest debt, you’ll also be making the minimum payment to your other debts.
The debt avalanche strategy is popular with people who are motivated by minimising the amount of money they spend on interest.
What types of debt can I include in the debt avalanche?
You can include all types of consumer debt in your debt avalanche:
- Credit card balances
- Personal loan accounts
- Student loan accounts
- Car loan
Some people decide to include their mortgage in their debt avalanche, while others pay this off later after getting rid of consumer debt.
Debt avalanche vs debt snowball
With the debt avalanche method, you pay off your debts in order of their interest rates, starting with the highest rate, then the next highest and the next highest. In contrast, the debt snowball method involves paying off your smallest debt first. Through paying off your smallest debt balance as quickly as possible, you build the confidence and momentum to pay off your next smallest balance and the next.
Fans of the debt snowball method believe it is an easier debt payoff strategy to stick to as you experience regular motivation boosts as you pay off smaller debt balances first. With these victories, it feels like you are making faster progress.
What are the advantages of the debt avalanche?
The main advantages of this approach to paying off debts is that you minimise the total amount of interest you pay by focussing on paying off your most expensive debt first.
What are the disadvantages of the debt avalanche approach?
The avalanche method to getting out of debt can require more self-discipline than the debt snowball approach to becoming debt-free. Your highest interest rate could be on your largest balance, which may take a long time to repay.
With the debt snowball approach, people can often quickly repay their smallest balance first, and this quick win spurs them on to pay off the rest. That’s why the personal finance expert Dave Ramsey recommends the snowball approach.
Conclusion: the best way to get out of debt is the method you will stick with
The debt avalanche method can be an effective method for anyone who is motivated by paying off debt with the highest interest rates, no matter what size the balance is and how long it will take. Others find that the debt snowball method is the most effective as their first debt is paid off sooner.
The most important thing is to pick a debt payoff plan that you are confident you can stick with, whether that involves starting with your highest interest rate bearing debt, the lowest balance, credit cards or some other approach. Simply making minimum payments for the long term is unlikely to lead to significant progress.
Frequently asked questions
What debts have a high-interest rate?
Credit card balances and payday loans often attract the highest rates of interest.
What is compound interest on debt?
Compound interest is where you pay interest on debt interest payments. If you are only making the minimum payment on your debts in some cases, this payment will not cover the interest you are incurring, and you will then pay interest on these interest payments.
Will my credit score improve if I use the debt avalanche program?
When you pay off your debt on time each month, your credit score often improves. You are demonstrating that companies can trust you to repay the money that you borrow. You may also see an improved score as you use less of your available credit.
Individuals who become completely debt-free may experience a drop in their credit score over time as there is less evidence of them taking out and repaying credit. The financial guru Dave Ramsey argues you shouldn’t focus on credit scores as he recommends saving up for things that you want, rather than paying with a credit card or other debt. For example, Dave recommends saving up to buy a car rather than taking out a car loan.
Why do I only make the minimum payments on my other debt accounts?
Research shows that the best way to pay off debt is to focus on one debt at a time. As you pay off your highest interest rate debt, the debt avalanche method recommends you only make the minimum monthly payment on all other debts. This approach enables you to make faster progress with your most expensive (highest interest rate) debt.
Is a debt consolidation loan a good idea?
Whether debt consolidation is a good idea depends on your specific circumstances. If you are drowning in high-interest debts such as credit card accounts, and struggling to find the money to repay your balances, then a consolidation loan may help. These loans may reduce your overall interest rate and structure the debt into more affordable monthly payments.
This type of loan tends not to be a good idea for individuals who can afford to meet their existing payments. In these cases, it can increase the amount of time an individual is in debt as you are often limited in the amount of overpayments you can make on a fixed interest rate debt balance.
Should I include student loans in my debt avalanche?
If your student loan balance has an interest rate on it, then the advice debt avalanche proponents give is to pay off the money you owe as soon as your student loan balance is the highest interest debt left. In some countries, student loan debt is more expensive than others. For example, it typically costs more in the United States than in the UK.
What about 0% interest credit card debt?
With the debt avalanche method, you would pay off a 0% credit card balance last as it is your lowest interest-bearing debt balance. If during your debt repayment plan, your 0% offer runs out, then you would pay more money to the account as soon as it is the debt with the highest rate of interest.
What should I do with the spare money once I’ve paid off my debts?
Dave Ramsey’s baby step approach recommends that you next save up three to six months of expenses in a fully-funded emergency fund once you are consumer debt-free. This fund provides security if you lose your income or face unexpected expenses in the future. Once you have this in place, you are unlikely to need credit to fund money you need in the future.
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