Debt Avalanche – Understanding the Repayment Method
In this repayment debt plan, the debtor allots adequate money to make a minimum payment on each debt; then devotes any remaining repayment fund to pay off the debt with the highest interest rate. Once the highest interest rate debt is paid off completely, the extra funds then go towards the next highest interest bearing debt. The debtor continues to observe this method until all debt is paid off in full.
This method is often considered as the alternative of snowball methods. In contrast to the debt snowball method, debt avalanche focuses on paying of credit card debt payments with high interest rates first.
The debt avalanche method is considered to be the logically and optimal way to pay debt off in the quickest manner possible. When you pay of the loan with the highest interest rate first, you will lower the amount of each payment that is associated to interest, at a much faster rate. Plus each payment will translate into more and more money to paying down the principal and the amount of debt you owe.
Advantages and Disadvantages of the Debt Avalanche Method
Here are some of the benefits that you can enjoy if you opt for the debt avalanche method,
1. Using this method of repayment, you can pay your debt off in the fastest manner possible
2. You can be confident that your money is being put to the best use possible in your debt paying off quest
3. You can save a good amount of money in the long run and more savings mean more money in hand, which can strength your financial position.
However, the downsides of using this method to pay off debts include:
1. The method requires patience as it can result in a long time to pay off your first loan which can put you in distress psychologically.
2. You will have to stick to the plan once you begin to realize the benefits of this debt repayment method.
3. You may require professional help to leverage the benefits of this method.
Debt Avalanche- How it Works?
Now let us take a look at how debt avalanche works. The calculation for debt avalanche requires interest rates for each debt account, mostly with an assumption that all debt accounts have the same tax liability. But if your tax liability varies, then it is advisable to perform this method once you determine your interest rate after taxes.
Here’s how this method works:
1. Organize your debts from the highest interest rate to the Lowest
2. Pay the minimum amount to all debts every month
3. Send all extra available cash you have to your debt with the highest interest
4. Repeat this process every month
For better understanding of the debt avalanche method, let us take an example:
Let’s assume you allocate a total of $500 every month to pay of three debt accounts:
- $1000 credit card debt with an annual rate of interest 20 percent
- $1, 250 car payments with an annual interest rate 6 percent
- And 1 $5,000 line of credit with interest rate of 8 percent
For simplicity purposes and ease of understanding, assume each of your account to have a minimum monthly payment of $50.
Now you will have to allocate at least $150 ($50*3) toward each debt account to make minimum monthly payment. The remaining amount is $500-$150=$350. This amount will be send to the money you devote to your highest interest debt. In this case, you will pay off a total of $400 to settle your credit card debt with the highest interest rate as we assumed above.
Once this debt account retires and is paid off in full, the extra payments will then go towards paying off the account with the highest interest rate, which are your car payments as assumed in this example. After the retiring of your second account, all $500 will then go towards the debt account of the lowest rate of interest.
The Debt avalanche method is an ideal way to pay off your unsecure credit cards loans easily with high interest rates. Using this method to pay off your debt, you can easily minimize the amount of interest you pay to your creditors due to late payments. Remember, credit and loans with high interest rates are among the top reasons that you find yourself over burdened with debt. The interest rate on debt combined with late fee charges blow up your debt payments. This makes it extremely challenging and difficult for you to pay off. Since this method targets repaying and retiring accounts with high interest rate first, it ensures that interest doesn’t accumulate as quickly. Imagine how much money you can save on interest?
For more information on the debt avalanche method or for professional assistance, get in touch with us today! Our debt consultants work in your best interest. We can evaluate your financial situation and recommend you the best debt repayment method accordingly.