IB.1.2 Strategies to Pay Off Debt

"The man who never has money enough to pay his debts has too much of something else."

Avalanche Method

The avalanche method is a debt repayment strategy that focuses on paying off debts with the highest interest rates first to minimize the amount of interest paid over time. Here’s a step-by-step guide to using the avalanche method:

 

Step 1: List All Debts
  • Gather Information: Make a list of all your debts, including credit cards, student loans, car loans, and any other debts.
  • Include Details: Write down the balance, minimum monthly payment, and interest rate for each debt.
Step 2: Order Debts by Interest Rate
  • Highest to Lowest: Arrange your list in order of the highest interest rate to the lowest interest rate.
Step 3: Make Minimum Payments
  • Stay Current: Continue making the minimum payments on all your debts to avoid late fees and penalties.
Step 4: Allocate Extra Funds to the Highest Interest Debt
  • Focus Payment: Identify any extra money in your budget that can be used to pay down debt.
  • Pay More: Apply this extra amount to the debt with the highest interest rate in addition to its minimum payment.
Step 5: Pay Off the Highest Interest Debt
  • Achieve First Victory: Once the highest interest debt is paid off, celebrate this milestone. This reduces the total interest you will pay over time.
Step 6: Roll Over Payments
  • Reallocate Funds: Take the total amount you were paying on the now-paid-off debt (minimum payment + extra amount) and add it to the minimum payment of the next highest interest debt.
  • Continue Payments: Keep making the minimum payments on all other debts.
Step 7: Repeat the Process
  • Next Debt: Focus on the next highest interest debt with your newly increased payment amount.
  • Reduce Interest: As each debt is paid off, the amount available to tackle the next debt grows, reducing the total interest paid.
Step 8: Continue Until All Debts Are Paid
  • Stay Consistent: Keep following this process until all your debts are paid off.
  • Final Push: As you approach the larger debts, you will have significant payment amounts to apply, speeding up the process.

Example

  1. List of Debts:

    • Credit Card 1: $1,000 balance, 20% interest rate, $25 minimum payment
    • Credit Card 2: $2,000 balance, 18% interest rate, $40 minimum payment
    • Medical Bill: $1,200 balance, 8% interest rate, $50 minimum payment
    • Car Loan: $7,000 balance, 5% interest rate, $200 minimum payment

  2. Order Debts:

      1. Credit Card 1: $1,000 balance, 20% interest rate
      1. Credit Card 2: $2,000 balance, 18% interest rate
      1. Medical Bill: $1,200 balance, 8% interest rate
      1. Car Loan: $7,000 balance, 5% interest rate

  3. Minimum Payments:

    • Credit Card 1: $25
    • Credit Card 2: $40
    • Medical Bill: $50
    • Car Loan: $200

  4. Allocate Extra Funds:

    • Assume you can allocate an extra $100 per month.

  5. Pay Off Credit Card 1:

    • Pay $125 per month ($25 minimum + $100 extra) until it’s paid off.

  6. Reallocate Funds to Credit Card 2:

    • After Credit Card 1 is paid off, pay $165 per month ($40 minimum + $125 from Credit Card 1) to Credit Card 2.

  7. Continue the Process:

    • Once Credit Card 2 is paid off, pay $215 per month ($50 minimum + $165 from Credit Card 2) to the Medical Bill.
    • Finally, pay $415 per month ($200 minimum + $215 from Medical Bill) to the Car Loan.

  8. Debt-Free:

    • Continue until all debts are cleared.

The avalanche method helps you save money on interest over the long term, even if it takes longer to see the psychological wins compared to the snowball method.

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