You will want to ask your bank to help you develop a plan to reduce and pay off your debt, either starting with the debts that have the highest interest rates first (the “avalanche” approach) or the smallest debts (the “snowball” approach). The debt with the highest interest rates may not be the largest in size, but due to the compounding effect of interest, you are likely to end up paying more in interest payments than the principal amount.
You may have multiple debts of varying sizes and interest rates, and it may be challenging to keep track of everything at once. To start, you will want to check with your bank about the exact loan amounts, interest rates and loan tenures. Once you have the nitty-gritty details sorted out, it will be easier for you to develop a repayment strategy.
As we’ve talked about above, you would also want to keep an eye on your budget. You may want to follow the 50:30:20 rule, dividing your after-tax income into three categories: essential needs (50%), discretionary spending (30%) and savings and investments (20%).
Note that high-interest debt repayment should be coming from the 20% category, while other debt repayments should be in the 50% category. This is because minimum repayments should be considered essential while paying off high-interest debt would save you extra principal and interest further down the road, which goes into the savings portion of your budget.
With the debt avalanche method, you pay off the debt with the highest interest rate first: this means that you’ll end up paying less interest in the long run. To see how this might happen, let’s look at an example:
Jack has three different debts to pay off:
Jack devotes $3,000 every month to pay off his debts:
To illustrate how the debt snowball method works differently from the debt avalanche, let’s take a look at Jack’s debts again.
Repayment:
By simply looking at the amount of interest paid and the amount of time needed to get rid of all the debt, you might be thinking the debt avalanche seems much better than the debt snowball. However, the debt avalanche takes much more discipline and motivation to implement, so it may not be for everyone. Since the smallest debts are settled faster with the debt snowball, creating a good sense of progress and more encouragement and momentum, many experts point to psychology and prefer that method.
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Of course, it needn’t be entirely an “either/or” question, and you could select a smaller high rate debt rather than the one with the absolute smallest debt or highest rate. Or the small debt with the highest rate! But whichever you choose: stick to it and don’t add any more debt to the pile!
Many avoidable and unavoidable things could have led to you having lots of debt, so don't be too hard on yourself; just start to take action today!
If you’re still unsure which method is better for you, you can check out a snowball vs avalanche calculator here, but ultimately, the best plan is the one you will stick to! Paying off debts needn’t be a headache, so after choosing a repayment method, remember the essentials: be punctual with your payments, have an emergency fund ready, and stick to your budget faithfully, and soon your debt burden will be as light as a snowflake!
TOO MUCH DEBT: DEBT REDUCTION. COMPLETED. ✅
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