One of the most daunting aspects of whittling down your debt is figuring out where to begin. If you constantly feel like the money you owe creditors is hanging over your head, the phrase “debt avalanche” may seem apropos.
But when it comes to this repayment strategy, you might find that it’s more than just its name that works for you.
What is debt avalanche?
Picture an avalanche, in which the highest peak begins crumbling toward the ground. The debt avalanche repayment method follows a similar trajectory. You tackle the debt with the highest interest rate first while still making minimum payments on all other outstanding balances.
The rationale behind this strategy is that you want to eliminate the loans that are costing you the most in interest. If you’re currently making minimum payments on those debts with the highest interest rates, you probably already know how devastating it can be to watch them mushroom month after month as you pay interest on interest. So it makes sense to try to rid yourself of your most costly debt as quickly as you can.
Once you’ve paid off your debt with the highest interest rate, you’ll move on to the one with the next largest interest rate, allocating the bulk of funds earmarked for debts toward this one while still making minimum payments the other loans.
Rinse and repeat until all your debts are repaid. (And then take a vacation. You earned it.)
Sign me up. How do I get started?
Make a list of your outstanding debts and determine which has the highest interest rate.
Let’s say you have three debts, and $750 per month to allot toward repaying them. If you have an auto loan with a balance of $4,000 at 4.2 percent interest, student loans with a balance of $22,000 at 3.6 percent interest, and $7,000 in credit card debt with an interest rate of 14.4 percent, the latter is the one you want to pay off first.
So, if each has a minimum payment due of $75, you’ll put $75 toward each of the debts with the lower interest rates — for a total of $150. You’ll devote the remaining $600 toward the one with the highest rate of interest — in this case, your credit card debt.
Once that’s paid in full, put that $600 toward the debt with the next highest interest rate. In our example, that’s your auto loan.
Shouldn’t you start with the largest debt?
It’s easy to get hung up on the wanting to throw the bulk of your money toward repaying the loan with the largest balance, but it’s most important to focus on where you’re losing the most money in interest.
The debt avalanche method is widely considered to be the most cost-effective as it results in fast repayment with less money going toward interest. (Another option is the debt snowball repayment method, which targets the debt with the lowest balance first.)
Don’t count out lowering your rates…
Don’t forget that at any time you can attempt to have your interest rates lowered. If you have credit card debt, start with the card you’ve held the longest as loyalty is always valued. Simply call and ask to have your rate lowered, and you might be pleasantly surprised. Then you’ll find yourself able to put more toward your principal, which is key to erasing debt as quickly as possible.
The debt avalanche method minimizes both the total amount of money you’ll spend in interest and the amount of time it takes to pull yourself out of debt because interest isn’t building on itself at the high rates.