Day 12: Creating a Debt Repayment Plan
Managing debt can feel overwhelming, but
having a clear debt repayment plan can help you stay organized, reduce stress,
and eventually achieve financial freedom. In India, where many people carry
various forms of debt such as personal loans, home loans, credit card debt, and
education loans, a structured repayment strategy is essential to ensure that
you are not overwhelmed by interest and fees.
In this post, we will discuss two popular debt
repayment strategies — the Snowball Method and the Avalanche Method — and
explore them through an Indian case study to illustrate how they work in real
life.
Debt Repayment Strategies
1. Snowball Method
The Snowball Method is a popular strategy
where you focus on paying off your smallest debt first, while making only
minimum payments on the larger debts. Once the smallest debt is paid off, you
move to the next smallest, and so on.
How It Works:
- List all your debts, from the smallest to the largest.
- Focus on paying off the smallest debt first while making minimum
payments on all other debts.
- Once the smallest debt is paid off, take the amount you were paying
toward it and apply it to the next smallest debt, continuing this process
until all debts are cleared.
Advantages of the Snowball Method:
- Psychological Boost: The Snowball Method offers a quick win with
the smallest debt being paid off first. This can provide a sense of
accomplishment and motivation to continue tackling your remaining debts.
- Simple to Follow: The method is straightforward and easy to
implement, especially for people who may feel overwhelmed by their debts.
Disadvantages:
- Potentially Higher Overall Interest Costs: Since you’re focusing on
the smallest debt first, you may not be paying off high-interest debts
quickly, which could lead to higher total interest payments.
2. Avalanche Method
The Avalanche Method focuses on paying off the
debt with the highest interest rate first, while making minimum payments on
other debts. This method helps minimize the total amount of interest paid over
time.
How It Works:
- List all your debts, from the one with the highest interest rate to
the one with the lowest.
- Focus on paying off the debt with the highest interest rate first,
while making minimum payments on all other debts.
- Once the high-interest debt is paid off, apply the amount you were
paying toward it to the next debt with the highest interest rate, and so
on.
Advantages of the Avalanche Method:
- Lower Total Interest Payments: By prioritizing high-interest debts,
you save money on interest in the long run, reducing the total amount you
owe.
- Faster Debt Payoff: This method can help you pay off your debts
more efficiently since you're tackling the most expensive debts first.
Disadvantages:
- Delayed Gratification: If you have several smaller debts with low
balances, you may not see quick progress, which can be discouraging. This
method requires patience.
Which Method Is Right for You?
- Snowball Method: If you need motivation and want quick wins to stay
encouraged, the Snowball Method may be the better choice. It’s ideal for
people who may feel overwhelmed by their debt and need to see progress to
stay motivated.
- Avalanche Method: If your main priority is minimizing the total
interest you pay over time and you can remain patient, the Avalanche
Method will likely be more cost-effective in the long run.
Indian Case Study: Anjali’s Debt Repayment
Plan
Let’s explore Anjali’s case to see how both
methods could work for an individual in India.
Background:
Anjali, a 32-year-old marketing professional
from Delhi, is managing multiple debts and is struggling to make progress in
paying them off. Her debts include:
- Credit Card Debt: ₹50,000 with an interest rate of 30% per annum.
- Personal Loan: ₹2,00,000 with an interest rate of 12% per annum.
- Education Loan: ₹3,00,000 with an interest rate of 8% per annum.
- Car Loan: ₹4,00,000 with an interest rate of 10% per annum.
Anjali earns ₹60,000 per month and has a
monthly repayment capacity of ₹15,000 for debt repayments after covering her
living expenses.
Using the Snowball Method:
If Anjali chooses the Snowball Method, she
would first focus on the smallest debt, which is her credit card debt of
₹50,000, despite its high interest rate. She would make the minimum payments on
the other debts and use her full ₹15,000 to pay down the credit card debt
faster.
- Step 1: Pay off ₹50,000 credit card debt (smallest debt).
- Anjali would allocate her ₹15,000 monthly payment to the credit
card debt, clearing it off in 3-4 months.
- Step 2: After clearing the credit card debt, Anjali would move to
her Personal Loan (₹2,00,000), paying it off next. She now has the full
₹15,000 available to apply to the personal loan.
- Step 3: Once the personal loan is paid off, Anjali would focus on
the Car Loan (₹4,00,000), and finally, her Education Loan (₹3,00,000).
This method allows Anjali to feel motivated
with quick wins but may cost her more in interest payments due to the high
credit card rate.
Using the Avalanche Method:
If Anjali chooses the Avalanche Method, she
would focus on the debt with the highest interest rate, which is the credit
card debt (30% interest), followed by her personal loan (12% interest), and
then the car loan (10%), and finally, the education loan (8%).
- Step 1: Focus on credit card debt (₹50,000 at 30% interest).
- Anjali would pay off the credit card debt first, but she would
also continue to make minimum payments on her other debts. This will save
her money on the interest costs in the long run.
- Step 2: Once the credit card debt is cleared, she would move on to
the personal loan (₹2,00,000) at 12% interest.
- Step 3: After paying off the personal loan, she would move on to
the car loan and then the education loan.
With this strategy, Anjali would save more
money on interest in the long run. The downside is that she may not experience
the same sense of accomplishment as quickly since the larger debts with higher
interest will take longer to pay off.
Which Strategy Should Anjali Choose?
If Anjali needs quick motivation to stay on
track, the Snowball Method could be the right choice. By focusing on the
smallest debt first, she would feel encouraged as she clears out each debt.
However, if she is more focused on long-term financial efficiency and can
remain patient, the Avalanche Method would save her more money in interest over
time.
Tips for Effective Debt Repayment in India:
- Make Extra Payments: If possible, make extra payments towards your
debts each month. Even a small additional amount can significantly reduce
your overall debt burden.
- Refinance or Consolidate: Look for opportunities to refinance
high-interest loans or consolidate your debts at lower rates, especially
if you have access to lower interest rates through personal loans or
balance transfer offers.
- Prioritize High-Interest Debt: In India, credit card debt and
payday loans carry high-interest rates, so prioritize paying them off as
soon as possible to reduce interest costs.
Conclusion:
Whether you choose the Snowball Method or the
Avalanche Method, having a clear debt repayment plan is critical to getting out
of debt and improving your financial situation. In India, where debt can
accumulate quickly due to high-interest rates on credit cards and personal
loans, it’s important to choose the right method based on your financial goals
and personality. Anjali’s case shows how both strategies can be tailored to
individual needs, and with the right plan, anyone can achieve financial
freedom.
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