Debt Smashing Strategies
*This article was originally published on February 2020 and has been kept in its original form
Paying off debt is neither fun nor easy, so one needs all the help one can get. There are two schools of thought on paying off debt: the Debt Avalanche or the Debt Snowball. Although both sound pretty daunting, both will get you to debt-free living, which one is right for you? Now considering humans are not just debt servicing machines but are actually emotional beings the biggest determining factor is to pick the option that you can stick to. One method will make you feel better about paying off debts and one is the more astute choice in terms of paying less interest.
First things first With both methods, you should do the following before getting started on your journey to a debt-free life. Write down all of your debts including:
• Value of outstanding debt
• Interest rate (that you are charged)
• Minimum payment to service the debt Do a budget exercise listing all of your expenses including:
• Fixed expenses – Things that don’t change
• Variable expenses – Things that change
• Fixed Income – Stable monthly income
• Variable income – Extra income from other sources
After the budget exercise is completed, you will now know exactly what your budget looks like. Pay specific attention to your expendable income – this is what is left after you have covered all of your expenses.
Next step is to CUT. What to cut you might ask? Well, first place to start is, unfortunately, all of the fun stuff, entertainment, subscriptions and essentially all expenses that aren’t absolutely necessary to your survival, the hint is to go look at your variable expenses. The goal here is to increase your expendable or usable income and then use most of it to service your debt. Great, now that you have the figures to work with we can move on to the next step of the exercise.
Debt Avalanche In short: Make the minimum payment on all of your debts but service the debt with the highest interest rates first – even if they are bigger and will take longer to settle. As soon as it is paid off, use that instalment to pay your next expensive debt and repeat until debt-free. So, the tactic here is to service the debt with the highest interest rates first in order for you to pay less interest over the repayment period, thus essentially increasing the amount of money used to service the debt versus just servicing the interest rates. This approach to debt management might not feel the best because there is a possibility that your loan with the highest interest rate might be your biggest one. But considering the minimisation of interest paid over the period, this is certainly the best option, which makes most financial sense.
Debt Snowball In short: Make minimum payment but put more money into the smallest debt and work your way up to the bigger ones. As soon as the smallest debt is paid off you take the instalment paid towards it and move it on to the next one and repeat until debt-free. Although not the best option in terms of minimising your repayments (including interest) but the benefit in this method lies in the fact that you will see tangible results (fast) and it should keep you motivated to continue this, sometimes doing the right thing gets addictive.
Example – A Case Study Let’s consider Max, who in our scenario has the following debts:
• R 50 000 – Student Loan – 9% Interest
• R 12 000 – Credit Card – 15% Interest
• R 120 000 – Vehicle Finance – 11.2% Interest
• R 22 000 – Retail Account – 21% Interest
Now let’s say that each loan has a minimum instalment of R1000 and Max has freed up an extra R1000 to service his debt. His repayments should look as follows under each method :
Snowball Method: Max will have to pay off the smallest loan first, which in his case is the Credit card after that he will move on to clear the retail account then the student loan and lastly the vehicle.
• R 50 000 – Student Loan – 9% Interest – Payment = R1000
• R 12 000 – Credit Card – 15% Interest – Payment = R2000
• R 120 000 – Vehicle Finance – 11.2% Interest – Payment = R1000
• R 22 000 – Retail Account – 21% Interest = R1000
Avalanche Method: Max will pay off the loan with the highest interest rate first, in his case the retail account then credit card after that the vehicle and lastly the student loan.
• R 50 000 – Student Loan – 9% Interest – Payment = R1000
• R 12 000 – Credit Card – 15% Interest – Payment = R1000
• R 120 000 – Vehicle Finance – 11.2% Interest – Payment = R1000
• R 22 000 – Retail Account – 21% Interest = R2000
What to do if it gets a bit much If circumstances led you to a point where you cannot service your debts properly, or you have no income for anything other than debt service, you can consider consulting with a proficient debt review consultant, in short how the process works is that they restructure and renegotiate your debt so that your monthly repayments are reduced giving you some breathing room, in most cases your interest rate will decrease, but your repayment term will increase – this is a much better option than defaulting on debt payments and liquidation. It is important to note that Debt Consulting is a specialist field (unfortunately also filled with sharks) and we do suggest finding a reputable company to assist you with this, if this is something you would like to know more about, feel free to reach out, and we will put you in touch with some of the best in the game.
Closing thoughts There is an adage which goes: “If you buy things that you cannot afford, soon you will have to sell the things you need in order to make ends meet”.
Before you buy anything, ask yourself these three questions: • Do I want it? • Do I need it? • Can I comfortably afford it? If one of the answers is no, don’t buy it.
If you have however amassed some form of debt, the best way to clear it is to face it head-on. Stay strong, stick to the plan and call in someone to help, a trusted advisor can go a long way to help you squash your debt. If you have cleared all your debt and you are wondering what to do with the open space in your budget – get someone to help you to save sufficiently for the future.
Remember what Albert Einstein said, those who understand compound interest earn it, those who don’t pay it.
