Not only is a certain amount of debt necessary in life, but it can be a good thing for credit.
Certain expenses are too big for most consumers to be able to cover with cash alone. That includes homes and vehicles. These types of purchases need the help of a loan to finance them.
But having some debt on the books can help build and improve credit scores. However, you’ll have to make regular payments missing any due dates. With every timely payment, your credit health can improve.
But too much debt can have the opposite effect. Mounting debt can place undue stress on consumers. It can also cause your credit score to dip if you miss payments.
In Canada, the average household debt is anywhere from $114,400 to $129,200. That’s a lot of debt to carry. And while many consumers can comfortably manage their debt, others cannot.
If you carry a lot of debt, you may find it tough to manage. In this case, your best bet is to do what you can to pay it down. This might sound difficult, but there are a couple of effective ways to pay down your debt.
One of these methods is the “debt avalanche method.”
But what exactly is the debt avalanche method, and how can you use it to pay off all your debt?
What is the debt avalanche method?
The debt avalanche method involves paying off your highest-interest debt first before all others. The faster you can pay off this debt, the sooner you can use that freed-up money to put towards other debts until you’re eventually debt-free.
The debt avalanche is the most efficient way to get out of debt because of how quickly it can work. The idea is to get rid of debt that’s costing you the most in interest.
Usually, credit card debt and payday loans come with the highest interest rates. Much of your money is going towards paying the interest portion of the debt. Meanwhile, the principal amount remains unpaid.
By getting rid of this type of debt sooner, you can free up the money used to pay interest to put towards paying other debt.
With the debt avalanche method, you pay as much as you can towards your highest-interest debt. Meanwhile, you continue to make minimum payments on the remaining debt you have. You’ll continue to do this until your highest-interest debt is gone.
Once you’ve paid off the first debt on your list, you can start focusing on the next highest-interest debt. You’ll follow the same steps by focusing on that one debt and making minimum payments on the rest.
The process continues until all your debts are gone.
To start this method, list all your debt in order of highest interest rate to lowest interest rate. Begin with the highest-interest debt first, then list the remaining in descending order.
Add up all the minimum payments you need to pay on your debt, then determine how much extra money you can pay every month beyond the minimums.
You can track your progress by creating a spreadsheet. This will help you see the type of success you’re achieving with each payment you make.
Why use the debt avalanche method?
The biggest benefit of the debt avalanche method is that it reduces the amount of interest you pay. At the same time, you can work towards your goal of becoming debt-free. It also reduces the time needed to get out of debt since less interest can accumulate.
Mathematically speaking, the debt avalanche method makes the most financial sense. After all, you’ll be spending less money in interest.
What debts should I pay with the avalanche approach?
Certain types of debt typically come with higher interest rates compared to others. This may include the following:
- Credit card debt
- Payday loan debt
- Bad credit loan debt
- Subprime mortgage debt
- Student loans
- Car loans
These bigger expenses come with naturally larger interest rates and borrowing fees. If you have several high-interest debts, consider making the avalanche method your preferred debt-reducing approach.
Who is the debt avalanche method best suited for?
The debt avalanche method is better for certain types of people over others. This includes consumers who are:
- Disciplined about paying down their debt
- Patient and able to wait a while before the first debt is paid off
- Accustomed to sticking to a budget
- Conservative with their spending habits
People who would prefer to see debt quickly taken out can try using the snowball method, starting with smaller debt.
The debt avalanche method makes the most financial sense to pay down debt. That’s because you can save a lot of money otherwise adding up in interest. Instead, you can put that money put towards more of the principal portion of debt.
Consumers who choose this method must be patient because it can take a while before the first high-interest debt is eliminated.
But if you’re able to stick it out, your debt repayment efforts can see faster results with each diminished debt. The sooner you start paying down your debt, the sooner you can realize financial freedom.