INTEREST FOCUSED
DEBT MANAGEMENT PLAN

Not all debt is bad debt, but most debt involves you paying someone back more than you borrowed. Once you find yourself in any kind of debt, lowering the extra amount you are paying back will eventually get you to a point where you can keep that money for yourself. The one constant thing you should always do is to make all the minimum payments you need to and then develop a plan to lower your debt with any extra money you can afford to pay. One of the two main approaches you can use to accomplish this is the Avalanche Method. People choose this method because this is the fastest way to pay off debt and could save you thousands of dollars compared to the other approach of the Snowball Method. 

WHAT IS IT?

The Debt Management Plan Avalanche Method is a method that requires you to arrange all your loans from the highest Annual Percentage Rate (A.P.R.) to the lowest Annual Percentage Rate (A.P.R.). With this plan, any extra money that you can afford to spend on making loan payments should be made on the loan with the highest Annual Percentage Rate (A.P.R.). Once that loan is paid off you now take the monthly payments you use to make to that loan, plus any extra money that you can still afford to spend on making loan payments and apply it to the next loan. This method allows you to pay off your loans with the least amount of added interest payments making it the quickest method to paying off all your debt. As you pay off each loan, it frees up money to be applied to the next loan instead and makes your payments avalanche from the top down in terms of the Annual Percentage Rate (A.P.R.). People may find this method challenging because if your largest Annual Percentage Rate (A.P.R.) is on a large loan balance, you may only be focusing on one loan for a long time as you work through this plan. However, it helps to keep in mind that this method saves you the most amount of money thanks to the money you save on interest payments.

Loan Examples

            The example of loans listed below will be used to review the avalanche debt management methods. Let’s say someone has the following loans:

• A Credit Card with a balance of $500 which requires a monthly minimum payment of $15 and has an Annual Percentage Rate (A.P.R.) of 20%. 
• A Car Loan that has a balance of $20,000 which requires a monthly payment of $500 and has an Annual Percentage Rate (A.P.R.) of 4%.
• A Mortgage that has a balance of $250,000 which requires a monthly minimum payment of $2,000 and has an Annual Percentage Rate (A.P.R.) of 6%.

Avalanche Method Applied

Using the loan example described, to approach paying off the debt with the Avalanche Method, you would first arrange the debts from the highest Annual Percentage Rate (A.P.R.) to the lowest Annual Percentage Rate (A.P.R.) which would be:

• 20% A.P.R. Credit Card with a $15 monthly minimum payment.
• 6% A.P.R. Mortgage with a $2,000 monthly minimum payment.
• 4% A.P.R. Car Loan with a $500 monthly minimum payment.

Note: The balance of the loan is not a factor that is considered in the Avalanche Method.

Let’s assume you review your finances and realize that you have a total of $3,000 that you can afford to spend on your loan payments this month. You would first make your monthly minimum payments so after the $15, the $500, and the $2,000 payments, you would have $485 extra that you can apply to your loan payments. With the Avalanche Method, you would apply it to your highest Annual Percentage Rate (A.P.R.) loan which is the Credit Card. Next month, with the Credit Card paid off and assuming that you still have $3,000 that you can afford to spend on your loan payments, you would make your remaining monthly minimum payments of the $500 on the Car Loan, and $2,000 on the Mortgage and apply the remaining money to your new loan with the highest Annual Percentage Rate (A.P.R.) your Mortgage. You would now have $500 extra that you can apply to your loan payments since you no longer need to make payments on the Credit Card because you have freed up the $15 you would have paid as a minimum payment on the Mortgage loan. You would now keep applying this extra payment to your Mortgage until that is paid off. Considering the loan examples being used, you will completely pay off the Car Loan with just the minimum payments before you finish paying off the Mortgage. This is completely fine because your additional payments are specifically going to your highest Annual Percentage Rate (A.P.R.) loan lowering the total overall interest that you pay on your loans combined every month. Your payments on a particular loan get larger and larger as you pay off the higher Annual Percentage Rate (A.P.R.) loans and redirect those payments to the loans with a lower Annual Percentage Rate (A.P.R.); this is similar to how an avalanche starts at the top and falls lower and lower.

The Avalanche method requires a lot of commitment and belief. The Snowball method is motivational because seeing fewer loans shows a quicker response to your efforts in your actions to eliminate debt. Saving more in interest in the Avalanche method may not seem as visible during the process, but you have to remind yourself that you are progressing towards paying off ALL your loans a lot faster with this process. Your interest is calculated on your remaining balance and the Avalanche method lowers the amount you are paying on interest and increases the amount you are paying on the principal amount. This frees up more and more interest payments to be utilized on the principal speeding up your process of getting to be debt free. The math is there, it simply requires you to understand it and keep in mind how it is working as you take on your debt. 

Why should I make the monthly minimum payments on all loans, can’t I just put all the money I have for loan payments on one loan at a time?

When you are late on payments or miss payments all together, the added fees and interest will make the amount that you have to pay back larger and as a result it will take you even longer to pay off the loan now. This will most likely also lower your credit score, which will impact your future ability to get new loans and will lead to loans with a higher Annual Interest Rate (A.P.R.). This will ultimately lead to your current loans and future loans taking even longer to pay off because you are paying higher interest. Therefore, no matter which debt management plan you choose, the one thing that stays consistent is that you should always make all your minimum payments.

How should I apply my payments that are in addition to the minimum payment?

Make sure that the additional payments that you are making are being applied the way that you intend. For example, some loan holders will not apply partial payments. This means that if your normal minimum monthly payment is $2,000 and you decide to pay an additional $50, this may not get applied to your payments because it is only a partial payment and not a full $2,000 payment. The loan holder will apply a payment once the remaining funds of $1,950 have been collected from you. You may need to directly contact the loan holder and ask them to apply your payment as a principal only payment. This will directly lower your total loan amount, without impacting the monthly minimum payment. For example, if your total loan amount left is $10,000 and you make a principal only payment of $100, this will adjust your new total loan amount to have a balance of $9,900. Any interest that is charged will now be evaluated based off the $9,900 balance and not the $10,000 balance, which ultimately will save you money in interest. 

Other Debt Management Plan: Snowball Debt Management Plan