Debt Avalanche: Definition and How To Use It

What Is a Debt Avalanche?

A debt avalanche is a type of accelerated debt repayment plan. Essentially, a debtor allocates enough money to make the minimum payment on each source of debt, then devotes any remaining repayment funds to the debt with the highest interest rate. Using the debt avalanche approach, once the debt with the highest interest rate is entirely paid off, then the extra repayment funds go toward the next-highest interest-bearing loan. This system continues until all the debts are paid off.

How Does a Debt Avalanche Work?

The first step in starting a debt avalanche strategy is to designate an amount of your available monthly income to pay debts. This amount should come from any funds not currently obligated for living expenses such as rent, grocery, daycare, or transportation. 

For example, say you have $500 available every month, after living expenses, to put toward paying down your debt. Say your current loans include:

• $1,000 on a credit card with a 26% annual percentage rate (APR)
• $1,250 on a personal loan with 12%
• $5,000 line of credit (LOC) with an 8% interest rate

For simplicity’s sake, assume each debt has a minimum monthly payment of $50. You would need to allot $150 toward paying each loan's minimum monthly payment ($50 x 3). The remaining $350 would be put toward your credit card, the highest-interest debt. After that you would put the extra money toward the personal loan until it is paid off. Finally, you would put all $500 toward your line of credit, which has the smallest interest rate.

How Debt Avalanche Reduces Interest

Advantages of the Debt Avalanche

The advantage of the debt avalanche method of debt repayment is that it reduces the amount of interest you pay in the long term. It also reduces the amount of time it will take you to get out of debt—assuming you make consistent payments—because less interest accumulates.

Interest adds to these debts because many loans have compound interest. The rate at which compound interest accrues depends on the frequency of compounding such that the higher the number of compounding periods, the greater the compound interest.

Disadvantages of the Debt Avalanche

The debt avalanche method requires discipline for consistency, which can be a downside for some people. Even with the best intentions of sticking with the debt-avalanche system, you may revert to making minimum payments on all the debts, especially if your financial situation changes. That’s why most financial planners recommend that people first save up a six-month emergency fund before attempting any accelerated debt payoff plan.

Debt Avalanche Vs. Debt Snowball

The debt avalanche is different from the debt snowball, another accelerated debt payoff plan. With the debt snowball strategy, the debtor uses money beyond the minimum payments to pay off debts from the smallest balance to the largest.

Although the debt snowball method does not save as much as the debt avalanche in terms of total interest charges, it can offer more motivation by eliminating small debts more quickly.

The Bottom Line

Whether the debt avalanche or the debt snowball method is best strategy to pay off debt will depend on you. Using the debt avalanche method will save you the most money in interest in the long-term, but some people find more success with the debt snowball method, which can be more motivating because you pay off a debt sooner.