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Tata Capital > Blog > Personal Use Loan > Debt Avalanche: Meaning, Pros and Cons, and Example

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Debt Avalanche: Meaning, Pros and Cons, and Example

Debt Avalanche: Meaning, Pros and Cons, and Example

Do you feel overwhelmed by your debt repayments and need help determining where to begin? The debt avalanche method for repayments could be just what you need!

The debt avalanche method is a strategy that simplifies the debt repayment process and helps you save significantly on interest costs. It's a strategy that requires patience, discipline, and a steadfast commitment to your financial goals. With this method, as you progress, you'll witness your debts diminishing at a quicker rate than with any other methods.

Read on to learn how to use the debt avalanche methods and take a step towards financial freedom!

What is the debt avalanche method?

The debt avalanche method is a strategic approach to paying off your debts by first prioritising the debts with the highest interest rates. This method is effective if you have multiple debts, such as personal loans, credit cards, car loans, education loans and property loans, each with a different interest rate. The primary goal of the debt avalanche method is to minimise the total interest paid over time.

Pros of the debt avalanche method

The debt avalanche method offers several advantages to help you manage and eliminate your debts more efficiently. Here's how it benefits you:

1. Save money on interest: You can minimise the total interest paid over the life of your debts by prioritising the debts with the highest interest rates. This is useful if you have debts with relatively higher interest rates, like credit card balances.

2. Quicker Debt Elimination: As you eliminate your highest-interest debts first, you'll be able to pay off your overall debt faster than other methods. This is because the amount you save on interest can be redirected to paying down the principal of your next debt more quickly.

3. Simplified Financial Planning: As you pay off each debt, you'll have fewer payments to juggle each month. This simplification can make your finances more manageable, helping you plan for the future,

Cons of the debt avalanche method

While the Debt Avalanche method has its advantages, it also comes with some drawbacks you should consider:

1. Complex budgeting: If your highest-interest debt also has a large balance, dedicating extra payments towards it while maintaining minimum payments on other debts can strain your budget. You must carefully manage your finances and possibly cut back on expenses to stay on track.

2. Requires patience and discipline: This method demands a high level of discipline and patience from you. Since you're tackling debts with the highest interest rates first, it might take longer to see your first debt fully paid off.

How does the avalanche method of paying debt work?

Let’s understand the working of the debt avalanche method with the help of an example.

Step 1: List all your debts

Begin by listing all your debts in order of their interest rates. Suppose you have the following debts:

1. Personal Loan: Rs. 2,00,000 at 12% interest per annum

2. Credit Card Debt: Rs. 50,000 at 40% interest per annum

3. Education Loan: Rs. 3,00,000 at 10% interest per annum

4. Car Loan: Rs. 5,00,000 at 15% interest per annum

Step 2: Arrange debts from highest to lowest interest rates

Now arrange all your debts from highest to lowest in terms of interest rates. This ranking determines the order in which you will tackle your debt repayments.

1. Credit Card Debt: 40% interest

2. Car Loan: 15% interest

3. Personal Loan: 12% interest

4. Education Loan: 10% interest

Step 3: Determine your monthly repayment budget

Let's assume you can allocate Rs. 40,000 each month to pay off your debts.

Step 4: Make minimum payments on all but the highest interest debt

Ensure you make the minimum payments on all your debts. This step helps keep your accounts in good standing and avoid late fees or penalties. For this, find out the minimum monthly payment for each loan, excluding the one with the highest interest rate.

Let's assume the minimum payments are as follows:

1. Personal Loan: Rs. 5,000

2. Education Loan: Rs. 3,000

3. Car Loan: Rs. 5,000

This means you would allocate Rs. 13,000 towards making the minimum payments on these three loans.

Step 5: Allocate the remaining budget to the highest interest-rate debt

Any additional money you have available after making the minimum payments should go towards the debt with the highest interest rate. This helps you reduce the amount of interest on your most expensive debt.

With Rs. 40,000 available and Rs. 13,000 allocated for minimum payments, you have Rs. 27,000 left. This amount goes towards paying off the Credit Card Debt, which has the highest interest rate.

Step 6: Repeat monthly and adjust as each debt is paid off

Once you fully pay off the debt with the highest interest rate, you take the total amount you were paying on that debt and apply it to the next debt on your list. This rollover effect increases the payment on the next debt, accelerating its repayment without increasing your overall budget.

Month 1: You pay Rs. 27,000 towards your Credit Card Debt, reducing it significantly. You must continue this pattern monthly.

Following Months: Once the Credit Card Debt is fully paid off, you move to the next highest interest rate debt, which in this case is the Car Loan. Now, you allocate the Rs. 27,000 plus the minimum payment you made on the credit card (since it's paid off) towards the Car Loan.

Continue this process, rolling over the payments to the next highest interest rate debt each time you pay one off until all debts are cleared.

Final thoughts

Consider the debt avalanche method if you have multiple loans to your name and need a strategy to repay them as quickly as possible.

An alternative to repaying loans using the debt avalanche method is debt consolidation using small personal loans. Tata Capital offers loans at competitive personal loan interest rates with minimal documentation and hassle-free approvals.

Visit the Tata Capital website or download the Tata Capital App to apply for a personal loan today!

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