Sweep Away Your Debt With a Debt Avalanche
People who are deep in debt often wonder how exactly they got there. Most consumer debt — credit cards especially — accumulates slowly over time. When people shop at the grocery store and end up with a larger bill than expected, they often resort to swiping their credit card. When they go to the movies and gripe about spending $50 on popcorn, candy, and soda for two people, they swipe their credit card. When the car breaks down, to pay for necessary repairs, they swipe their credit card. Soon enough, all those swipes add up. People suddenly find themselves staring down a $10,000 balance and a $300 minimum monthly payment.
One of the best ways to tackle debt works in the exact opposite fashion from the slow, glacial pace at which the debt is accumulated. It's designed to pay down debt as fast and efficiently as possible, an ever-quickening, ever-growing financial cascade. After all, what's the best way to get rid of a glacier of debt? The answer is…
The debt avalanche
Debt usually comes from many different sources, just like a massive river is fed by smaller tributaries. There are credit cards, auto loans, personal loans, and medical bills, all adding up to one large, seemingly-insurmountable hunk of debt.
Except that those smaller sources of debt are important to distinguish from one another. One of the most frustrating parts of debt is that it constantly grows due to the interest being assessed. However, not all interest rates are the same, some are higher than others.
By making debts with the highest interest rates a priority, you can pay down your debt faster and ultimately save more money than you would by paying them all off at an equal rate. This focus on interest rates, rather than the principal, is the key to the Debt Avalanche, and is what distinguishes it from the Debt Snowball method.
To best illustrate how the Debt Avalanche works, let's use the same example that we used to illustrate the Debt Snowball. A hypothetical person named Bill tallied all of their loans and credit cards together and discovered that they had $44,500 in debt. This was negatively affecting Bill's credit score, so they decided to start paying off all their debt immediately. In the previous post, Bill used a Debt Snowball. Let's see how things would have been different if they had used a Debt Avalanche.
Bill began by organizing all of the debts in ascending order from the highest APR to the lowest. It's best to use APR instead of just the interest rate because the APR will factor any additional fees that are charged. The spreadsheet looked something like this:
| Name of Loan | Principal | APR | Monthly Minimum |
|---|---|---|---|
| Visa Card | $3,000 | 19% | $77.50 |
| Personal Loan | $8,000 | 15% | $322.00 |
| Master Card | $17,000 | 14% | $368.33 |
| Macy's Card | $1,500 | 13% | $31.25 |
| Car Loan | $15,000 | 9% | $362.5 |
After trimming the spending, Bill was able to set aside $2,000 a month for debt repayment. As they were already spending $1,161.58 per month on the minimum payments, this left them with an extra $838.42 per month to start paying off their debt.
Bill started with the Visa Card because it had the highest interest rate: 19%. By adding the $838.42 to the $77.50 monthly minimum they were already paying for a total of $915.92. The principal on the Visa Card was $3,000. Four months later, it was $0.
Bill then moved on to the personal loan, which had an interest rate of 15%. Taking the $838.42 in additional money plus the $77.50 Visa Card monthly minimum that was no longer required was then added to the $322.00 monthly minimum for the personal loan. In total, Bill was now paying $1,237.92 toward the personal loan's $8,000 principal. It took seven months to pay it off.
Continuing in this fashion, it took Bill eleven months to pay off the Mastercard, only one month to pay off the Macy's Card, and eight months to pay off the car loan. All in all, Bill went from $44,500 in the hole to entirely debt-free in 31 months; that's just over two-and-a-half years.
With the Debt Snowball, it took Bill 32 months to pay off all their debt. Now, one month might not seem like a huge difference, but, remember, Bill was paying $2,000 every month. Shaving off just that one month saved them $2,000.
The argument in favor of the Debt Snowball, made by people like financial guru Dave Ramsey, is that it gives people easy and early "wins" that encourage them to keep going. This is true. However, the math favors the Debt Avalanche method as the fastest and cheapest way to get out of debt.
Maybe it helps to think about it like this: what would you rather show up to a snow fight with - a snowball or an avalanche?
