What is the Avalanche Calculation?
Most people have heard of the Snowball Calculation when it comes to paying off debt, not so many have heard about the Debt Avalanche Calculation, which is shocking!
The idea behind using the Avalanche Calculation is to eliminate the higher cost debts first with the intention of avoiding as much interest as possible.
An Avalanche Example
Compared to the Snowball technique, the Snowball method is incredibly simple.
- Credit Card A has a balance of £1200, an interest rate of 18% and zero charges.
- Credit Card B has a balance of £1200, an interest rate of 30% and zero charges.
- Credit Card C has a balance of £300, an interest rate of 0% and £5 monthly charges.
Now that we have the basics down on these debts, it's time to work out the APR - or effective interest rate when considering all charges.
A note to remember, the avalanche method does not take into consideration where the debt is, as it is irrelevant - the only thing that matters is what the cost is for each debt.
- Credit Card A effectively has an 18% APR, which is a monthly interest rate of (18% / 12 Months) 1.5%
- Credit Card B effectively has an 30% APR, which is a monthly interest rate of (30% / 12 Months) 2.5%
- Credit Card C effectively has an 20% APR, but how did we get there? - (£5 Charge / £300 Balance) x 12 Months = 0.2 (20%)
- Now if we look at Credit Card C again with a different balance, for example £100: 60% APR - (£5 Charge / £100 Balance) x 12 Months = 0.6 (60%)
From this example we can predict that when after some months of making our minimum & larger payments, that the priority of larger payments will change to allow for Credit Card C to be paid first, give it's overall cost is 60% which is higher that both A & B; 18% & 30% respectively.