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Debt Avalanche: Meaning, Pros and Cons and Examples

Published on Apr 29, 2024Updated on May 7, 2024

Debt Avalanche: Meaning, Pros and Cons and Examples

In the journey towards financial stability and freedom, understanding and effectively managing debt is crucial. One such method that ensures this when used wisely is the debt avalanche method. This approach can not only help individuals handle debt in an efficient manner but also help them save money in the long run.

In this article, we’ll discuss the meaning of debt avalanche, its pros and cons, and how to decide whether it is the appropriate strategy for your financial goals.

What is the Debt Avalanche Method?

‘Higher interest rates, higher priority’ is how you can sum up what debt avalanche is about. The debt avalanche method is a strategic approach to repay debts, particularly for individuals whose debts have a wide range of interest rates.

The concept behind this approach is to tackle the loan with the highest interest rate first. If you have a specific amount set towards debt repayment per month, you first pay the minimum monthly amount for all your debts and what remains from the budget, you put it towards paying off the loan with the highest interest rate. 

For example, you have taken out three loans:

  1. Credit Card Debt: INR 50,000 with an interest rate of 18% per year.
  2. Personal Loan: INR 80,000 with an interest rate of 15% per year.
  3. Car Loan: INR 1,00,000 with an interest rate of 12% per year.

Here’s a table to help you visualise it:

 

Balance

Interest rate

Minimum payment per month

Credit Card Loan

INR 50,000

18%

INR 1,250

Personal Loan

INR 80,000

15%

INR 2,250

Car Loan

INR 1,00,000

12%

INR 2,500

With the avalanche method, you focus on paying off the debt with the highest interest rate first, which in this case is the credit card debt at 18%.

Let's say you have a monthly budget of INR 10,000 for debt repayment. After making the minimum payments on all debts, you allocate the remaining amount towards the credit card debt. Let's say that's INR 4,000 extra per month.

With this approach, you're attacking the high-interest debt aggressively while making minimum payments on the other debts.

Once the credit card debt is paid off, you take the INR 4,000 you were putting towards it and add it to the minimum payment you were making towards your personal loan repayment. Now, you're paying more towards your personal loan each month, accelerating its repayment.

You repeat this process until all debts are paid off. By prioritising debts based on interest rates, you save money on interest payments and become debt-free faster. That's how the debt avalanche method works. 

Pros and Cons of Debt Avalanche 

Pros of Debt Avalanche

  • Cost savings: The debt avalanche strategy prioritises paying off debts with the highest interest rates first. By focusing on high-interest debts, you can save money on interest payments over time. This approach is mathematically optimised to minimise the total amount paid in interest, allowing individuals to become debt-free faster compared to other methods.
  • Mathematically sound: The debt avalanche strategy is based on sound mathematical principles. By prioritising debts based on interest rates, individuals can minimise the overall cost of debt quicker.
  • Efficient: The method is efficient in terms of debt repayment. By targeting high-interest debts first, you can free up resources for other financial goals such as savings, investments, or discretionary spending.

Cons of Debt Avalanche 

  • Requires discipline: Implementing the debt avalanche method requires discipline and commitment. You must consistently allocate extra funds towards high-interest debts while making minimum payments on other debts. Without discipline, it's easy to go off track and accumulate more debt, negating the benefits of the strategy.
  • Longer time to see progress on larger debts: If you have high-interest debts with large balances, such as a mortgage or student loans, it may take longer to see significant progress with the debt avalanche strategy. This can be unideal for those who prefer quick wins in their debt repayment journey.
  • Limited flexibility: The debt avalanche method may not be suitable for individuals with fluctuating income or unpredictable expenses. Since it prioritises paying off debts based solely on interest rates, it may not provide the flexibility needed to address immediate financial needs or emergencies.

Debt Avalanche vs Debt Snowball

When researching debts and their repayments, it is easy to mix the concept of debt avalanche with debt snowball due to their similar goal of debt repayment. They differ, however, in the way they approach these goals.

Debt avalanche prioritises paying off debts with the highest interest rates first, with the aim of saving more money in the long run by minimising interest payments. Debt snowball, on the other hand, focuses more on building momentum and motivation through quick and smaller wins. It does this by paying off debts from smallest to largest balance regardless of interest rates.

Even though both methods aim to reduce debt for the individual, the debt avalanche strategy may save more money overall, while the debt snowball strategy provides psychological satisfaction and momentum. Understanding the difference between the 2 strategies is crucial for making informed decisions on managing your debt effectively.

How can a Personal Loan for Debt Consolidation Help?

While the debt avalanche method can be useful when followed wisely, it still involves keeping track of multiple loans. If you are finding it difficult to manage multiple loan repayments combining your debts into a single loan might be able to help.

A debt consolidation loan is where multiple debts are combined into a single loan or repayment plan. The new loan may also come with a lower interest rate than the individual debts, making it easier for the debtor to manage their payments and potentially save money on interest over time.

Depending on individual circumstances and financial goals, either the debt avalanche method or debt consolidation loans – or a combination of both – can be effective tools in reducing debt and working towards financial stability. Evaluating every option carefully is essential in order to choose an approach that best aligns with your financial situation and objectives.

SMFG India Credit offers personal loans for an amount of up to INR 25 lakhs* for debt consolidation. With interest rates starting at 11.99% per annum* and flexible repayment tenure of up to 60 months, you can consolidate existing debts into a single loan with more easily manageable terms. Get in touch with us online or visit your nearest SMFG India Credit branch for more information.

* Please note that this article is for your knowledge only. Loans are disbursed at the sole discretion of SMFG India Credit. Final approval, loan terms, disbursal process, foreclosure charges and foreclosure process will be subject to SMFG India Credit's policy at the time of loan application. If you wish to know more about our products and services, please contact us

FAQs

When is it a good time to implement the debt avalanche method?

Debt avalanches could be used when you have multiple debts with high-interest rates, like credit cards. It helps you save money in the long run by focusing on paying off the most expensive debts first, freeing up cash for future savings and investments.

Is debt avalanche and debt snowball the same thing?

No, the 2 are different debt repayment methods. While the debt avalanche method focuses on paying off debts that have the highest interest rates first, the debt snowball method prioritises paying off debts from smallest to largest balances regardless of interest rates.

How to choose between a debt avalanche and a debt consolidation loan?

Choosing between the 2 depends on your individual financial situation and goals. If you have multiple loans with different interest rates and reducing the time you spend on loan repayments is your goal, a debt avalanche may be the better choice. On the other hand, if you prefer simplifying your debt payments into a single loan with potentially lower interest rates, a debt consolidation loan may be more suitable.

What are the advantages of a debt avalanche?

Some of the benefits of a debt avalanche are:

  • By prioritising high-interest debts, you save money on interest payments over time.
  • It can help you to cut off a few years from your loan repayments.
  • Overall, it minimises your total debt and gives you a faster opportunity to be debt-free.

How to start a debt avalanche?

Here are some ways to start a debt avalanche:

  • List all your debts: Include balances and interest rates.
  • Set a budget: Allocate a specific amount for debt repayment each month.
  • Pay minimums: Ensure you pay the minimum on all debts.
  • Target high-interest debt: Use any remaining funds to aggressively pay off the debt with the highest interest rate.
  • Repeat the process: Once the highest-interest debt is paid off, focus on the next highest-interest debt until all debts are cleared.

What are the factors you should consider before choosing debt consolidation?

Debt consolidation is ideal when the new interest rate is lower than the average interest you are paying on your existing debts. Debt consolidation loans often have criteria such as a strong credit score. If this is not met, you may get a higher interest rate even with debt consolidation. Moreover, it is necessary to practice discipline in repayment and spending habits so as to not end up increasing the debt burden.

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