Trying to get debt free? Here are some of the strategies to help you
In most of the financial planning cases, one goal is common across all the investors and that is trying to get debt free. The mounting debt of different types can become very stressful during financially challenging times. In most cases, high-interest loans like credit card debt, personal loan eats up most of the regular cash flow. But if you approach this problem systematically then it is possible to achieve your goal of getting debt free.
Today, we will share some strategies which help you in reducing your liabilities.
Debt Snowball Strategy
Snowball strategy is basically paying off your smallest loan first. The concept behind snowball is that you start with a loan that has smaller outstanding and slowly move to loans with higher outstanding. Here’s how you can use this strategy.
- Firstly, arrange all the liabilities in smallest to largest order in terms of the outstanding amount. No matter what the interest rate is.
- Pay the maximum amount possible for the smaller loans and pay the minimum payment for other loans. In other words, transfer the installment payment from higher loans to smaller loans.
- Once the smaller loans are paid off, you can start paying the next in line.
- Continue doing this till all of your loans are paid off.
Why does this strategy work?
We have said this before and say it again now. In your personal finance journey, the behavior plays most important role. Trying to tackle multiple loans at the same time can be difficult. In such a case, the behavioral part comes into play. When you pay off small loans, they get over faster and that gives the motivation to pay other loans as well. As you pay smaller loans, you also get more cash in your hands, the same cash can now be used to pay bigger loans.
Debt Avalanche Strategy
In this strategy, you target the loans with a higher interest rate first. High-interest loans are often called toxic loans due to the exorbitant interest charged by them. Credit card debt is one of the examples of toxic debt. Here’s how Debt Avalanche Strategy works:
- Arrange all your loans in order of higher interest rates to lower interest no matter what the outstanding amount is.
- Pay the maximum amount towards the loan with a higher interest rate. And pay a minimum amount due to other loans.
- Once the first loan from the list gets paid off, move on to the second one.
- Do this until all your loans are paid off.
Why does this strategy work?
In cases of high-interest loan, the interest portion makes the most of the total outstanding. When you pay off the loans with high interest, you can manager other loans better. Here’s why: when you pay the high-interest loans, out of your repayment, a larger portion goes towards interest than principal. Once you prepay these loans, low-interest loans will be easier to deal with as your repayment actually reduces your outstanding amount faster.
Which strategy should you go for to get debt free?
Do you need the motivation to pay off your loans? Are you a person who gets motivated by small victories? If yes, the Debt Snowball is the right strategy for you. Since the loans with small outstanding get cleared faster, it is easy to reduce the total number of loans. Such achievement can give you the much-needed motivation to pay off remaining loans.
The Debt Avalanche is the right strategy for you if you can be disciplined over the long term and continue to follow through on the prepayment plan. High-interest loans impact the cash flow adversely and hence making them your first priority works in your favor. However, if the outstanding is higher, you will take some time to pay off the loan. Hence, discipline is a must while adopting the Debt Avalanche strategy.
But what if you do not want to decide between these two and want another way out? There is a third option which you can look into:
If you have multiple loans and you are getting stressed about multiple EMIs, then you can opt for debt consolidation. Using this strategy, you can take one personal loan for debt consolidation. In this, you will get a lump sum amount to pay off all your loans and you will have to pay only one EMI at a reasonable interest rate.
This strategy is useful especially in case of multiple high-interest loans. Instead of taking the burden of the high interest, you can pay off these loans and shift to low-interest personal loans.
But to make any of these strategies successful, you need to reduce lifestyle expenses substantially so that you generate enough cash to pre-pay the loans. A little discipline in managing your finances goes a long way.
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