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The debt avalanche method for repayment

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    Quick insights

    • When you have multiple outstanding debts, the debt avalanche method is a way of approaching repayment.
    • To apply the debt avalanche method, you’d aim to pay off loans in order of their interest rate, from highest to lowest.
    • Responsible debt repayment has financial benefits, and the avalanche method might be right for you.

    Do you have debt you want to pay off but don’t know where to start? There are different strategies that might provide the blueprint to becoming debt-free someday. This is our guide to the debt avalanche method.

    What is the debt avalanche method?

    The avalanche method is an approach to debt repayment that typically involves making additional monthly payments to one loan at a time. The priority is paying down loans based on their respective interest rates. You start by concentrating on the loan that has the highest rate, which can accrue interest rapidly and make a loan increasingly more difficult to pay off.

    What is debt stacking?

    This is another term for the debt avalanche method because, to apply it, you list (or “stack”) your debts from highest to lowest interest rate. Tackling high-interest loans before lower-interest ones can save money on interest and eventually help people become debt-free.

    How the avalanche method works

    Here’s how you can apply the debt avalanche method to your loans and lines of credit:

    1. List all your debts in order from highest to lowest interest rate.
    2. Plan to make minimum payments on all debts.
    3. Identify an amount in your monthly budget or savings account that you can put toward paying off the debt with the highest interest rate.
    4. Continue the process of paying off the next debt on your initial list once you pay off a loan.

    Debt avalanche method example

    • You have three loans with different interest rates: A has 10%, B has 5% and C has 3%.
    • Make sure you can make the minimum payments on each loan.
    • Extra money you have should be paid on Loan A (10% interest), each month or on some regular basis, until it’s paid off.
    • Once Loan A is paid off, the minimum payment you were making plus any extra you put toward it should go toward paying off Loan B, the 5% interest loan.
    • Minimum payments should continue on the Loan C (3% interest).
    • Once Loan B is paid, you’d concentrate on paying off Loan C.

    Tools and resources to implement the avalanche method

    Online calculators and budget templates can help you apply the debt avalanche method. Once you know which loan you’ll attack first, use your budget to figure how much money each month you can pay toward your highest-interest loan. With these tools, you can estimate how long it may take for you to be debt-free.

    What debts should you pay off first in the avalanche method?

    If you have outstanding credit card balances, those will usually be at the top of a debt list that’s organized by interest rate. The reason you’d prioritize high-interest credit cards and loans is to avoid your total debt from rising because of interest charges.

    When you want to decide between paying debts with similar interest rates, consider prioritizing the one with the lower outstanding balance. Paying off one loan could free up the money spent on it each month for paying off the next loan on your avalanche list.

    How does the avalanche method eliminate debt?

    The debt avalanche method prioritizes paying off certain loans to save money on interest charges over time. The overriding premise of this method is to pay off all your debts, one loan at a time. Once you pay off a loan, you can apply money previously spent on its monthly payment to another loan. Regardless of the time it takes, you can apply the debt avalanche method until all your debt is eliminated.

    Common mistakes to avoid with the avalanche method

    Here are some possible budgeting mistakes that happen when applying the debt avalanche method:

    • Neglecting smaller loan balances: The debt avalanche method focuses on interest rates. This could distract people from an opportunity to pay off a smaller debt, which could help jumpstart the debt avalanche method. If you can afford to pay off a smaller loan, what you’d spend on the monthly payment could go immediately to your highest-interest debt.
    • Accruing additional debt: When focusing on debt repayment, avoiding new loans can be helpful. New loans come with new monthly payments that you have to factor into your budget. When this gives you less money to put toward paying off debt, your progress with the avalanche method could slow.
    • Not confirming prepayment penalties: Certain loans and lines of credit charge a penalty fee for paying off the balance ahead of schedule. This is called a prepayment penalty, which will be outlined in the loan’s terms and conditions. You can confirm if this penalty applies before fully paying off a loan.

    Benefits of the avalanche debt repayment method

    Here are some of the benefits of applying the debt avalanche method:

    • Psychological benefits: Saving money on interest and seeing debts disappear can boost financial confidence.
    • Saving on interest: Additional payments that reduce the principal balance on an interest-bearing loan can save on total interest charges. Most loan interest compounds monthly based on the outstanding balance of the loan. The lower the balance, the less interest is charged over time.
    • Freeing up money: Paying off a debt means monthly payments are no longer due. You can roll that amount into paying off the next debt or use a portion to improve your cash flow.
    • Potential credit score improvements: As debts are paid down, your credit utilization ratio can decrease. That’s one factor used in calculating credit score, which can improve as the ratio declines.

    The debt avalanche method vs. other debt repayment strategies

    The debt avalanche method is just one debt repayment method. Others may be more beneficial depending on personal goals and financial situations.

    Snowball method

    This strategy centers on paying off debts from the smallest outstanding balance to the largest. It can boost motivation as each debt is eliminated and can help you make overall progress toward becoming debt free.

    Debt consolidation

    Consolidation is the process of combining multiple debts into a single loan with a single interest rate. In this way, debt repayment may be more straightforward, as there aren’t multiple lenders and bills to pay regularly.

    Debt management plan

    This is commonly offered by credit counseling agencies and certain lenders to help borrowers repay debt. A plan is still has required, regular payments. Accredited agencies may provide professional guidance and plans tailored to each person’s financial situation.

    In conclusion

    When you’re not sure where to start paying down debt, having a strategy is worthwhile. It can provide specific steps that are based on your budget but lead to your end goal: no more debt. The debt avalanche method might save you money on interest charges by having you first concentrate on paying loans accruing the most interest. Over time, as each loan is paid, you can roll over money in your budget from one debt to the next, gradually becoming debt-free.

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