What is the ‘debt avalanche’
Debt avalanche-this type of accelerated repayment plan the debt. In particular, the debtor allocates enough money to make the minimum payment on every debt, and then devotes any remaining debt-repayment of funds to the debt with the highest interest rate. Using the debt avalanche method, when the debt with the highest interest rate is completely paid off, additional funds to repay the advance to the next highest interest loan. This method continues until all debts are paid off.
Breaking the debt avalanche’
The first step in using the debt avalanche approach is to identify the total amount of monthly income to pay debts. This amount any funds not currently required for expenses like rent, grocery, childcare and transport costs.
As an example, imagine you have $500 available each month after payment of the costs of debt repayment. Your current credits include:
- 1,000 USD for credit card debt with an annual interest rate of 20%
- Us $1,250 monthly payment a car at the rate of 6% per annum
- Line for $5,000 of credit (loc), with 8% interest rate
For simplicity, assume that each debt has a minimum monthly payment of $50, with the exception of a car loan where the minimum payment will be the regular monthly premium.
You will need to allocate $100 to pay the minimum monthly payment for each debt ($50 x 2). The remaining 400 $will add to the money dedicated to a high percentage of debt. In this example, you should pay a total of $450 to pay the credit card debt charging 20% per annum. The card debt will be fully repaid in the fourth month, assuming no additional charges shall be credited to the card balance. Now additional funds will go to retire, the second-highest interest-bearing debt, line of credit. Finally, all 500 $will go into debt with a low interest rate car loan.
The Debt Avalanche Reduces The Interest, But Requires Discipline
The advantage of the avalanche of debt is that it minimizes the amount of interest You pay while working towards your debt free goal, as long as you stick to the plan. It also reduces the amount of time it takes to get out of debt, assuming constant payments, less interest accumulates.
Interest adds to these debts, because lenders use compound interest. The level at which compound interest is awarded based on the frequency of interest calculation such that the greater the number of periods, the more compound interest. Most credit card balances compound interest on a daily basis, but there are loans where interest can be monthly, semiannually or annually.
The disadvantage of debt avalanche is that it takes discipline and determination to pull off. It is easy to return to make the minimum payments on all debts, especially after unforeseen expenses such as car or home repairs. That’s why most financial planners recommend that you save up to six month emergency Fund before any debt payment plan accelerator.
Different from the debt Snowball
The avalanche of debt differs from the debt snowball, another plan accelerator. In the debt snowball, the debtor uses the money above the minimum payments to pay off debts with the smallest balance to the largest. Although this method is more expensive, the total amount of interest payments, the debt snowball method motivated with the elimination of some small debts.