"Do you want to build a snowman...during an avalanche?" - The Debt Avalanche Payoff Method
So last week, we discussed a method to paying off your debt known as the Debt Snowball Method. This week we are upping the personal finance ante. Snowballs are safe, but what about an avalanche sort of mentality to paying off your debts. Let's go!
What's this method all about?
So again, I want you to picture yourself outside in the snow. This time though, you're at the top of a snowy hill about to build your debt snowman. You pack snow into a ball and you begin to roll that snowball around to build it to the size of the base of the snowman. But because you're at the top of a hill, the ball of snow begins rolling downhill, picking up speed, and getting large fast. That's the idea of the Debt Avalanche Method. The debt avalanche method involves paying off your balances with the highest interest rates first. This plan prioritizes financial efficiency and is one of the cheapest ways to get out of debt.
Arrange all of your debts by interest rate, from highest to lowest (Remember to budget enough to cover the minimum monthly payment for every debt). Every month, put the extra money you budgeted for getting rid of debt toward your debt with the highest interest rate. Once the debt is repaid, take the entire amount you were paying toward it (monthly minimum plus your extra money) and target the next highest interest rate debt.
Pretend you have the following debt:
Credit Card 1 - $2500 (@ 13.5%): Monthly payment $65
Credit Card 2 - $3000 (@ 19.8%): Monthly Payment $85
Student Loan 1 - $7000 (@ 5%): Monthly Payment $80
Student Loan 2 - $5500 (@3.5%): Monthly Payment $70
Medical Bill - $500 (interest free); Monthly Payment $45