Companies like Carina Advisors, Ladder Advisors and Credit 9 have been flooding the market with unrealistically low-interest rate offers that promise a bit more than they can actually deliver. How do those companies compare to the debt avalanche method? Many people are not aware of the dangers that can befall them when they are trying to get out of debt. It is important to understand the risks involved in seeking an online personal loan for debt consolidation as opposed to the debt avalanche method.
Many people acquire heavy debt in their lives. Whether you’re investing in your education, starting a business, building a house or buying a really nice car, the truth is you can accrue debt for any reason. However, paying it off is usually the tricky part.
A Personal loan for debt consolidation is a useful financial tool for paying off debt, however, there are two other equally popular methods. The first is the debt avalanche method. The second is the debt snowball method. The latter is known for its emphasis on quick wins and the buildup of momentum. However, the debt avalanche method pays off debt a little differently.
What is Debt Avalanche?
This term refers to an accelerated debt pay off plan. It has the debtor allocate enough money to make the minimum payment on each source of debt. Then, the remaining repayment funds are devoted to the debt that has the highest interest rate. Hence, the debt with the highest interest rate is paid off first. This way, the highest interest rate and debt is prevented from aggregating. Then, you move on to the debt that accrues the second-highest interest. This avalanche of debt payments continues until the end of the payoff.
What is the Approved Method?
In order to successfully pull off this method, you need to set aside a certain amount of income every single month. This amount should come from income that isn’t set aside for things like monthly expenses, rent, food, travel expenses, etc. You should also not dip into your savings for this.
Assume that you have about $400 available every single month for your debt after daily expenses. Your current loans can include a monthly car payment and a line of credit with an X% interest rate. Let’s throw in a credit card payment with a 20% annual rate to make things a little more interesting.
To make this all simple, you should assume that every debt has a monthly payment of $50. This excludes the car loan, of course. You should allot $100 towards each loan’s payment. So that makes it $100. With the remaining $300, you should pay off the debt with the highest interest rate.
This will go on until you’ve paid off that high-interest rate debt. Then, you can move on to the second-highest interest rate debt. This method has helped hundreds of thousands clear their debt successfully. However, it does require a lot of discipline.
You need to stick to a budget, and maintain your savings and monthly expenses. Even if you get a raise, you should put more money towards clearing your debt than raising your lifestyle standards.
Pros and Cons of Debt Avalanche
There are many pros to clearing your debt with the debt avalanche method. However, there are some disadvantages too. It all depends on how well you’ve disciplined yourself and your financial situation. Let’s get to the pros first.
The advantage of this method is clear. It helps you get out of debt quicker by paying off the largest ones. It’s backed up by a lot of simple math. If you get rid of the debt that is bound to get bigger faster, then you can clear your debt faster.
It also doesn’t disregard your other debt. It keeps the ball rolling on all of them so you can pay them off too. It works in descending order of magnitude for each debt. Hence, when you’re done clearing most of your big debt, you’re left with a few of the small ones. In essence, that’s what a debt avalanche does. It eradicates debt.
A lot of lenders tend to use compound interest. To offset its snowballing effects, the avalanche takes the biggest debt amounts down first. A lot of credit card balances and other loans will compound interest every single day. However, there are loans where the interest can compound monthly, semi-monthly, etc. The avalanche method is about stopping all of that.
Debt avalanche is a technique that requires a lot of discipline to make it work. It requires commitment and a strict schedule and spending budget. If you veer away from it, it can upset the system in place.
Also, if you veer away from your budget due to unforeseen expenses, it can be more than a little inconvenient. Sometimes, people just can’t help purchasing something expensive or reduce their expenditures. At times, there are emergencies that can’t be put off.
This is why a lot of financial planners recommend that you save up nearly six months of your salary for an emergency fund. This is to ensure that you don’t blow your savings trying to pay off your debt if you get fired. So before you attempt any debt avalanche payoffs, you should acquire more than six months’ salary in your bank account.
Debt Avalanche vs. Debt Snowball
The snowball method, as mentioned before, is based on compounding wins instead of going big. It counts on building momentum and paying off bigger and bigger debt as you get closer to your goal. It doesn’t start off with paying off the biggest debt amounts that you have.
Hence, it’s the direct opposite of what the avalanche method is. Snowballing is based on celebrating bigger and bigger wins as time goes on. It depends on you taking control of your debt as time passes. However, according to simple mathematics, it should be a much harder method than the avalanche to pull off. If you allow interest to compound and not pay off your biggest debt first, you may end up broke. There may come a time with the snowball method that you’re buried under debt.
The trick with the snowball method is that it encourages people to pay off bigger and bigger loans. Hence, it’s more a motivator than anything. With debt avalanche, you can pay off the biggest debt first; however, you may lose momentum. After you’ve paid off the biggest debt, you may feel inclined to skip one month or even two. That’s never good for your debt. Compound interest stops for no one.
Both of these methods have their pros and cons. However, what matters is the commitment that you have to paying off your debt. In the end, your will and determination are what will get you through any debt storm; avalanche or snowball.