Debt Avalanche: Meaning, Pros and Cons, and Example

Understanding the Debt Avalanche Method

Having a pile of overdue loan repayments and unpaid credit card bills can have a negative impact on your credit profile. It doesn’t only lead to a decline in your credit score but also causes a lot of financial distress. 

When navigating your way out of debt, it’s important to have a solid repayment strategy in place. This can include tricks and approaches that make your monthly repayments easier, without sacrificing your financial stability and goals. 

Some popular methods include the debt snowball method, debt avalanche method, taking out a debt consolidation loan, balance transfer, etc. If you’re someone who has multiple ongoing loans and credit card bills, then the avalanche method debt is your way to go. 

But what exactly is the avalanche method and how does it work? Keep reading this blog to find out. 

What is the Debt Avalanche?

The debt avalanche method is where you prioritize those debts first that have a high-interest rate. If you have multiple debts like personal loans, credit card debt, education loans, etc. then using the debt avalanche approach can be an effective method for paying back your outstanding.

Arrange your loans based on their interest rate and prioritize those loan repayments first that have the highest interest rate. The end goal of this approach is to reduce the total interest you need to pay as quickly as possible. However, make sure you’re paying at least the minimum monthly payments across your other outstanding loans.

How Does the Debt Avalanche Work? 

Now that you know what a debt avalanche is, the next step is to understand how it works. 

The first step is to make a list of all your debts. Make sure you include the outstanding balance amount, the interest rate on the loan and the minimum monthly payment for each loan. 

Next, arrange all your debt in the order from the highest to lowest interest rate. You will get a clear understanding of the loans that need to be paid first. 

While you’re paying your high-interest loans, make sure you repay at least a minimum monthly amount towards your other outstanding loans. 

Once you have paid off the debt with the highest interest rate, move down to the next loan. Make sure you keep doing this until you’re completely debt-free. 

When following the debt avalanche method, you will notice a gradual reduction in the total amount of debt you’re repaying. 

Advantages of Using the Debt Avalanche

If you’re someone who is juggling between multiple credit and loans, then using avalanche method debt to pay back your outstanding debt can be very beneficial. Using this approach can help you save money on interest which automatically reduces the overall loan amount you have to pay. Other than that, when you pay back the high-interest debts first, you will be able to become debt-free quickly. This way, you’re not only reducing the total outstanding debt you have to repay but also the life of it. The debt avalanche is ideal for individuals who want to save money on their overall outstanding and want to become debt-free quickly.  

Disadvantages of the Debt Avalanche

Debt avalanche is an ideal option only for those individuals who have the financial capacity to pay more than the minimum amount. This is because, while focusing on your high-interest debts, you still have to pay a minimum monthly amount across all your other outstanding debt. And because the payments made in the initial stages of avalanche method debt are high, it can be a little difficult to stay motivated. It is important you carefully evaluate your total outstanding debt and your financial situation before opting for this method.

Example of Debt Avalanche in Action 

Here’s an example to understand the debt avalanche method better. Consider you have 3 ongoing debts-  

 Debt 1: Credit card with an outstanding balance of Rs.1,00,000 at an annual interest rate of 12%. 

 Debt 2: Two-wheeler loan with a balance of Rs 2,00,000 at an annual interest rate of 18%.

 Debt 3: Education loan with an outstanding balance of Rs. 3,00,000 at an annual interest rate of 8%.

According to the debt avalanche method, you need to start paying your two-wheeler loan first while paying a minimum monthly payment across your credit card and education loan. 

After you have completely paid off your two-wheeler loan, you need to start paying your outstanding credit card bills while making a minimum monthly payment for your education loan. 

This way you will save money on your overall debt and clear all your outstanding quickly. 

Step-by-Step Guide to Using the Debt Avalanche

Consider the above example to better understand the step-by-step process of using the debt avalanche method to become debt-free. 

Step 1: Make a list of all your debt. 

Based on the above example, the list of debt will be looking something like this: 

Debt 1: Credit card with an outstanding balance of Rs.1,00,000 at an annual interest rate of 12%. 

Debt 2: Two-wheeler loan with a balance of Rs 2,00,000 at an annual interest rate of 18%.

Debt 3: Education loan with an outstanding balance of Rs. 3,00,000 at an annual interest rate of 8%. 

Step 2: Arrange the debt in order of highest interest rates to lowest.

When you arrange your debt in the order of highest interest rates to lowest, your list will be like this: 

-Two-wheeler loan with a balance of Rs 2,00,000 at an annual interest rate of 18%. 

-A credit card with an outstanding balance of Rs.1,00,000 at an annual interest rate of 12%. 

-Education loan with an outstanding balance of Rs. 3,00,000 at an annual interest rate of 8%. 

Step 3:  Create a budget for repaying your personal loan. 

Carefully analyze your current financial situation and debt to set aside a particular amount that you will solely dedicate to your debt. For example, consider that you can set aside Rs. 50000 to repay your outstanding loans. 

Step 4:  Make minimum payments on all debts except for the ones with the highest interest. 

Determine the minimum amount you have to pay across all the other outstanding debt except for the one with the highest interest.

In this scenario, you will not take the two-wheeler loan into consideration. 

Assume that you need to pay at least Rs. 10,000 towards your credit card bill and Rs. 15,000 towards your education loan. This means Rs. 25,000 out of Rs. 50,000 will be solely dedicated towards making minimum monthly payments. 

Step 5: Keep the rest of the budget for high-interest payments 

Dedicate the remaining Rs. 25,000 towards paying your two-wheeler loan. 

Step 6: Repeat Step 1 – 5 

After you have completely paid off the two-wheeler loan, repeat steps 1-5. 

Conclusion

Clearing your ongoing debt will not only help you improve your overall credit health but also relieve you from your financial obligations. Of the many habits that make an individual financially healthy, being debt-free is a very important one. 

If you’re finding it difficult to navigate your way out of debt, then you can implement some effective strategies to come out of it. Some of these could be the debt avalanche method, debt snowball method, or even debt consolidation loan. 

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