The debt avalanche method is the fastest way to pay off your debts, so it can save you a stack of money in the long run.
While a ‘debt avalanche’ sounds like you’re about to wiped off the face of the earth by debt, it’s actually the opposite. Instead, it’s a debt repayment method that aims to get you out of the red as quickly as possible.
We’ve investigated the snowball method of repayment before (click here to learn all about it). It’s the one where you pay off your smallest debt first, rolling into the next smallest, then the next and so on. You do that until you’ve paid off even your largest debt.
With the snowball, it doesn’t matter what interest rate you’re paying on your loan. All that matters is that you pay down your debts in order of smallest to largest. It’s a great way to build momentum and motivation, because you quickly eliminate the number of debts you have. It really does feel great to owe less money to less creditors.
By contrast, the debt avalanche method starts big by targeting your highest interest rate debt first and gradually tapers off as your debts get smaller. Which makes complete sense, right? I mean, the higher your interest rate, the more you’re ultimately going to pay to loan the money.
So the debt avalanche method can save you money and time. You’ll pay less interest on your debts, plus you’ll pay them back faster.
How to use the debt avalanche method
This is a simple debt strategy at heart. The steps are:
- List all of your debts and the current interest rate you’re paying
- Order your list from the highest interest rate to the lowest
- Make your minimum monthly repayments on each of your loans
- Pay as much extra each month as you can on the highest interest rate loan
- Once you’ve paid off the highest interest loan, cross it off your list (yay!)
- Continue to pay the minimum monthly amount on each of your loans and direct your extra repayments to the next loan on your list
- Keep going until you’ve paid off all of your debts.
Why debt avalanching works so well
The debt avalanche method is the most financially sound way to pay off your debts, if you can stick with it. Logically, you want to pay off your credit card with its 19 per cent interest rate, rather than your BNPL loan that charges zero interest and only a small monthly fee. After all, as long as you meet your minimum monthly repayment obligations, some loans don’t cost you much at all.
Credit card interest compounds, which means if you get charged interest it will be added on top of your existing debt. Then next month, they’ll charge you interest on your original debt amount plus the interest amount. And so on and on until you suddenly find that you owe $2,000 (or more) for something that originally cost $600.
That’s the mighty power of compounding that builds so well when you’re saving, but turns into a wrecking ball when you’re in debt.
Highest interest rate to lowest
To see how that works in action is to truly understand the debt avalanche method.
If you owed $5000 on a credit card charging 19.74 per cent per annum and paid only the minimum $100 repayment each month, it would take you 8 years and 10 months to pay off your debt. You will have been charged $5,596 in interest – more than the initial amount you borrowed.
Making an extra repayment of just $50 a month would have the debt repaid in 4 years and 1 month and saved you $3,288 in interest. Pay $200 a month instead of the minimum $100 and you’ll knock the debt off in 2 years and 9 months and save yourself $4,102. That’s right, finding an extra $25 or so a week would end up freeing up a ton of money to pay down your other debts.
No doubt about it, the debt avalanche method is the best debt repayment system for beating compounding. Pay down your debts by highest interest rate to lowest interest rate and you’ll end up paying less money overall.
Why you might choose another debt repayment method
If avalanching saves you so much money, why wouldn’t you use it? In fact, it makes so much sense, why do other methods like the snowball even exist?
The answer to that is as complex as human motivation itself. A Harvard study concluded that people generally did better concentrating on one debt at a time (that is, using either the avalanche or the snowball, rather than adding extra repayment to every debt they had). But while it makes logical sense to use the avalanche, psychologically most people are generally more motivated when paying off their smaller debts first (using the snowball method). In other words, the more debts you pay off, the more likely you are to keep paying off your debts.
It can take a while to see your progress using the debt avalanche method, especially if your higher interest rate loans are also your higher balance loans.
One way to keep motivated while you’re chipping away is to keep your eye on the bigger picture. Regularly use calculators like this one to keep punching in your ‘extra repayment’ amounts to see the difference the extra money will make to your debt over time.
If you can keep on keeping on, you’ll definitely save a stack of money repaying your debts using the avalanche method, rather than the snowball. You’ll also get out of debt faster, which will free up your money to use compounding to your advantage at last.