Avalanche strategy

A client with four loans and some spare money each month has to decide which loan gets it. The avalanche strategy answers purely on cost: pay off the borrowing with the highest interest rate first.

The logic is that the highest-rate loans are the most costly, so clearing them is expected to bring down the interest burden fastest. The lower-rate loans do not hurt the financial situation as much and can be paid off later.

It is the mathematically driven one of the three strategies the workbook describes for reducing debt faster. Snowball orders loans by amount instead, for motivation, and blizzard blends the two.

The workbook example. A borrower has:

Avalanche order: credit card → personal loan → car loan → housing loan. High interest-bearing debt goes first.

The risk the workbook names. If the higher-rate loans are small in absolute amount, paying them off first will not reduce the interest payment pressure as much as expected. Rate is only half of the interest bill; the balance is the other half.

How it fits the rest of the chapter. The debt re-scheduling advice in 4.3.4 is the same principle — rank debt in order of cost and deal with the costliest first. Credit card dues and personal loans are typically the most expensive; low-cost debt with tax benefits, such as home and education loans, can be dealt with later when finances permit.

Compared with the alternatives:

The loans are the workbook's; the Rs 1,00,000 and the one-year interest comparison are illustrative, using simple annual interest.

The borrower above receives a bonus of Rs 1,00,000 to put towards debt. Annual interest on each loan today: card Rs 12,600, personal loan Rs 25,200, car loan Rs 12,000, housing loan Rs 1,20,000 — Rs 1,69,800 in all.

Avalanche saves Rs 6,300 more a year with exactly the same Rs 1,00,000. The snowball borrower has the satisfaction of closing two loans (card and car) instead of one; the avalanche borrower has a larger personal loan still open but a smaller interest bill.

Notice what happened in the first step: the card is both the smallest and the costliest debt, so the strategies agree there and only diverge afterwards. Notice too the workbook's risk in action: the 42% card, being only Rs 30,000, saves Rs 12,600 a year — less than the Rs 14,700 saved by putting Rs 70,000 against the 21% personal loan.

Chapter 4 (Debt Management and Loans), section 4.15.1, with snowball at 4.15.2 and blizzard at 4.15.3; the cost-ranking principle also appears in 4.3.4 (debt re-scheduling). The workbook's own sample question asks what is paid first under the avalanche mode — the loan with the highest interest rate. Expect to be given a list of loans and asked for the repayment order under each strategy.

• Avalanche = highest rate first; snowball = smallest amount first. The sample question offers "highest amount" and "lowest amount" as distractors.
• Blizzard starts like snowball and then switches to avalanche. It is not a third ordering rule.
• Interest saved depends on rate and balance together. A tiny high-rate loan may save less than a larger, lower-rate one — the risk the workbook names.
• The housing loan comes last in every strategy in the example — lowest rate, largest balance, and tax benefits.
• Do not confuse avalanche with refinancing. Avalanche changes the order of repayment; refinancing replaces a loan with a cheaper one.