The debt avalanche method is the strategy of paying off debts, regardless of their balance, from highest interest rate to lowest rate. Much like the debt snowball, you live on a written budget, and as you eliminate one debt at a time, you allocate those funds to the next bill until all non-real estate debt is paid off.
On paper, the debt avalanche is the most efficient way to pay off debt, and saves you more money in the long run. By focusing on the highest interest rates first, you are attacking the principal balances of credit cards or loans with high interest, cutting down on the time (and money) that will get tacked on the original amount you borrowed.
Related: The Debt Snowball Method Explained
If you are currently making payments on three credit cards and one auto loan, and the balances and interest rates were as follows:
- Visa Credit Card with $2,500 balance and 15.9% interest rate
- Mastercard with $1,000 balance and 20.9% interest rate
- American Express Credit Card with $1,400 balance and 27.9% interest rate
- Auto Loan with $9,000 balance and 5.9% interest rate
Since the American Express card has the highest interest rate, you will start there in the debt avalanche method, paying chunks on the $1,400 balance until it is paid off. Once you have this card paid off, move on to the Mastercard, and then the Visa, and finally the Auto Loan.
By paying these credit card balances down first, your FICO score will see a likely jump after your payments are recorded and reported to all three credit bureaus. That increase could open up opportunities for you to do a balance transfer on a card or loan with a high interest rate to another card/loan with a lower rate. Should that opportunity present itself, you can weigh out the benefits of consolidating the debt and making just one payment vs. pushing forward on your original plan.
As mentioned when we covered the debt snowball method, before you commit to any strategy of repayment, you have to personally commit to not getting back into debt. It is no need to pay off these credit cards or loans if you are going to turn back around and max the cards out again. This is where personal finance gets personal. The math and the logic says the debt avalanche method may be the way for you to go, however you have to make sure your reason why you are getting out of debt is strong enough to withstand any temptation that arises. If you are a natural spender, that may mean doing what I had to do, which was pay off and then close much of my revolving credit. At one time, I had over a dozen credit cards, some with very small balances, opened due to a promotion of some sort, and others owned for years that were essentially a psychological security blanket financially.
Credit cards are not savings accounts, and not meant to supplement your lifestyle in between paychecks. Auto loans should be avoided when all possible. If you commit to personally getting out of debt, and staying out of debt, consider the debt avalanche method as an ideal way to eliminate lingering credit card, student loan, and auto payments for good.
Bonus – Check out CNNMoney’s Debt Free Calculator to determine how many months it will take you to become debt free if you make zero changes to your current budget.