The Debt Avalanche Payoff Method

If you’re swamped in debt and it’s harder each month to at least pay your minimum credit card balances, inaction isn’t an option. But how do you tackle what could be a half dozen credit cards, all with balances screaming for attention?

The answer might be financial triage. Somehow you need to prioritize your debts and follow a coherent plan for paying them off sequentially. It almost certainly will require a change in lifestyle, allowing you to direct your cash at debt elimination.

Then you need to decide which debt to focus on first.

Financial counselors often recommend one of two strategies: a debt avalanche or a debt snowball. Both approaches require that you make minimum monthly payments on all your credit cards, but then they diverge.

What Is the Debt Avalanche Method?

Debt avalanche advocates say you should focus on the debt with the highest interest rate first, while the snowball proponents want you to focus on the credit card with the smallest balance.

Though both methods evoke images of wintery white stuff and both promise a path to restored financial health, the avalanche technique focuses on saving money by reducing interest expenses, while the snowball offers a psychological boost each time you clear balances.

Both share a common thread: Making the minimum required monthly payments on everything you owe, then focusing on eliminating your debt, one balance at a time.

Using the avalanche method assumes you have enough income to meet essential living expenses, cover minimum monthly payments on outstanding debts and still have money left over to start paying off what you owe.

It won’t work if you can’t allocate at least some money each month to paying off credit card balances, but you won’t know until you make a budget and stick to it.

Some ways to create extra income in your budget would be eating out less, skipping out-of-town vacations, buying clothes only when you need them, brown bagging lunches at work and pulling back on any other discretionary expenses that add to your debt load. After doing some arithmetic, you might find $500 or $600 a month that you can apply to your avalanche debt-payment plan.

The approach is simple. Determine which of your unpaid balances carries the highest rate of interest and start paying it off, while still making minimum payments on the other accounts.

Your focus should be on credit cards, which usually charge very high interest rates on unpaid balances. Whatever money is left over after you pay all required expenses should be applied to this debt. Once it is paid, move to the one with the next highest interest rate. The method allows you to spend less and less each month on interest.

Using the Debt Avalanche

Consider making a ledger for each of your credit cards, noting the interest rate on the top of each entry. Then make entries for your other debts. These include student loans, mortgage payments, home equity lines of credit (HELOCs), car payments, medical debts and whatever other payments you’re required to make each month.

Call this your data set. Next, take a look at your savings account. Do you have at least six months income in an emergency account? If not, build a reserve that you won’t touch unless you lose your job or face some other crisis. Once the emergency account is secure, it’s time to enter the avalanche.

Since secured debt, the kind that uses collateral such as you home or an automobile, almost always carries lower interest that an unsecured debt (e.g. credit card or a personal loan), focus on the unsecured debt. Using your ledger, start applying your uncommitted monthly income to paying down the balance with the highest interest rate. It doesn’t matter whether this is your largest or smallest balance, just focus on the one with the highest interest and pay off that balance before paying more than the minimum on the next highest balance.

Our credit card payoff calculator will help you determine how long it will take to zero-out the balance of a credit card by making extra payments.

Here’s an example of several debts and how to apply the avalanche method:

• A HELOC with a $10,000 balance at 5% annual interest.
• Credit Card A carrying a $2,000 balance at 25% APR.
• Credit Card B carrying a $3,500 balance at 18% APR.
• A $12,000 car loan with a 7% interest rate and a $287.35 monthly payment.

First, disregard the HELOC and the car loan. You should continue making the required monthly payments and not consider making extra payments until you other debts are settled. Next look at the credit card interest rates. Though the balance on Card B is higher, the interest rate is lower, so focus on Card A, making extra principal payments until the debt is paid off. Then move to Card B.

Debt Avalanche Advantages

The debt avalanche technique is all about interest. Interest payments, from your perspective, are a total waste of money. Lenders pay themselves with the interest they collect and all you get is the privilege of staying in debt. The debt avalanche minimizes the amount you waste on interest by paying off the balance with the highest rate attached to it. Simple, right?

Though it saves you money in the long run, it’s not always easy to stay on plan. If you have a large debt at a high interest rate, it might take a long time to achieve the gratification of eliminating the debt. Though it might seem more rewarding to pay off a card with a low balance, it isn’t the most cost-effective approach. The trick to make the avalanche work is to constantly remind yourself that interest rate is the enemy and it makes sense to take down the biggest enemy first.

Because you are chipping away at the amount of the highest interest you’re paying, you will get out of debt faster using the avalanche than any other approach. But it takes discipline. Keep reminding yourself that each dollar you don’t pay in interest is a dollar you can use for you own purposes.

When to Use the Avalanche vs. the Debt Snowball

Some financial advisers suggest the debt snowball method of paying down balances. Though it’s indisputable that the debt avalanche saves more money in the long run, the debt snowball offers more immediate gratification, since it gives users a sense of accomplishment as they pay off credit card balances.

The debt snowball is the flipside of the debt avalanche. Debtors pay off the unsecured debt with the smallest balance first, then move to the next smallest balance no matter what interest rates they charge. If you had a big debt on a credit card with a high interest rate, it might take months to pay off. Debt snowball advocates say that can discourage debtors and make it less likely that they will stick with a get-out-of-debt program.

The bottom line: The debt avalanche method saves you money and pays off debts in the shortest amount of time, but it requires discipline. The debt snowball gives you a sense of victory every time you pay off a card balance but probably means you pay more interest before settling your debts.