“I am looking to pay off my debt as fast as possible, but I am not sure where to start.” Sound familiar? You’re not alone. There are numerous recommendations out there for how to pay off your personal debt, (ie: establish a budget, drain your savings, get a HELOC, etc…) but the one that I like like a lot is referred to as the debt avalanche method.
The avalanche method is very similar to the popular debt-snowball method that Dave Ramsey endorses, however, it is more efficient and results in the debt being paid off faster. It does assume though, that you have excess money, above just paying the minimum required payments, to pay down the debt. The way it works is like this.
First, determine how much money you can pay per month toward your debt. For the purposes of this example, I am going to use $1,500 as my available monthly capital for debt repayment.
Next, determine the current amount you owe for each account, the minimum payment due each month for that account, and the annual interest rate.
As you can see, my minimum monthly payments add up to $1,239, which leaves me with $261 per month to apply toward these debts. Instead of trying to split up the $261 between multiple accounts, we are going to sort each account by the annual interest rate. Our extra funds will be applied toward the account with the highest interest rate.
* New Payment for Lowe's Credit Card = min $22.50 + $261
We are now on pace to payoff the Lowe's Credit Card in less than four months. Once we do we will take the $283.50 we were applying toward the Lowe's card and add that to our Macy's Card payment. The new payment to the Macy's card will be $20.83 + $283.50 = $304.33 and it will be paid off in three months. Now we move down to the Visa Card doing the same thing.
* Visa Card Payment = $261 + $22.50 + $20.83 + $46.00 = $350.33
Assuming we have not added new debt along the way, by the time we get to the Student Loan, we will be in a position to apply $1,500 per month to that account.
As you can see, the avalanche method does require one to be disciplined in paying off their debt, but provides an efficient path to doing so while reducing the amount of total interest paid. It is not for everyone, but I think a pretty good argument could be made that if you are able to follow this disciplined approach to paying off the debt, you will likely be very successful at sticking to a retirement savings plan, as well!
Kevin Warman, CIMA®, RMA®
(last updated 05/04/2015)