Today, accessing credit and getting approved for loans is easier than ever before. You can apply for most types of loans online and get funds disbursed to your bank account quickly, sometimes within just a few hours. However, managing that debt can get tricky. If you are struggling to pay off your debt but don’t know the best way to go about it, here are some strategies that can help you get started.
Strategies for paying off debt
Here are some commonly used strategies for paying off debt in a manageable manner:
- Debt snowball strategy
When you have an overwhelming amount of debt and feel discouraged, the debt snowball method can be helpful. Here, the idea is to first tackle those debts that are smallest in terms of their amounts, and then move on to bigger ones. This debt repayment strategy can help you build momentum in paying off your debts. As you see more and more of your debt balances being cleared, you may feel encouraged.
To follow the debt snowball strategy, begin by making a list of all the debts you owe. Identify the smallest outstanding balance and prioritise paying it off first. Remember, your goal is to first pay the minimum amount due the smallest loans, and then channelling any excess funds towards paying off bigger loans.
Say you have three outstanding loans — a personal loan of ₹2 lakh, credit card bills of ₹75,000, and a car loan of ₹8 lakh. In this case, if you were using this strategy, you would first aim to pay off your outstanding credit card bills.
- Debt avalanche strategy
This debt repayment strategy also starts by making a list of all your existing loans. However, here, instead of focusing on your outstanding balance, what we focus on is the interest rate on each loan. The goal is to first pay off the loan with the highest interest rate in order to reduce your interest burden.
Most loans, especially unsecured loans like personal loans and credit card dues, come with quite high interest rates that can lead to a debt trap. Hence, under the debt avalanche method, the idea is to pay off the highest-interest-rate loans as quickly as possible while paying the bare minimum on other loans.
For instance, if you have a credit card loan with a 30% annual interest rate and an education loan with a 18% annual interest rate, the debt avalanche strategy would lead to you tackling the credit card loan first. This debt repayment strategy requires a relatively high level of discipline, consistent budgeting, and motivation to be successful.
- Debt consolidation
Debt consolidation is a strategy that can be effective when you have several different loans to pay off with varying interest rates, repayment schedules, and terms. You can consolidate all your debt into one loan by opting for a balance transfer through a personal loan.
Here, the new lender providing you with the balance transfer loan pays off all your existing lenders on your behalf. It then consolidates all those loans into one loan with a single interest rate and Equated Monthly Instalment (EMI) schedule, making it easier for you to manage your debt.
The primary advantage of debt consolidation is easier debt management and saving on late fees. In some cases, you can also negotiate for a lower interest rate or better terms, especially if you have a long-standing relationship with the lender or bank.
Tips for managing credit effectively
Even after you have paid off your existing debts, you might continue to need access to various forms of short-term and long-term credit in the future. Hence, it is essential to keep certain tips in mind to manage credit effectively and remain financially healthy:
- Avoid bad debt
Not all debt is created equal — there is good debt and bad debt. Good debt is debt that benefits you financially in the long run. For instance, taking out an education loan that will help you pursue a degree that will significantly increase your earning capacity in the future. Conversely, bad debt is debt used primarily for consumption purposes that doesn’t provide any long-term financial benefits. For instance, taking a personal loan to go on a Euro trip. For such purposes, it’s best to budget and save money over time instead of taking a loan to immediately fulfil your wants.
- Budget consistently
It’s crucial to maintain a budget in order to track your expenses and understand your spending patterns. If you do not budget, you might not uncover areas of your life where you might be overspending, and might even remain unaware of certain automated payments draining your hard-earned money. When you are trying to pay off debt, budgeting consistently and identifying discretionary expense categories where you could reduce spending is helpful.
- Limit credit utilisation to 30%
Even when you have access to credit, say in the form of a credit card, it is recommended that you not utilise the entirety of your credit limit. A credit utilisation level of 30% or below should be maintained. This will not only help you improve your credit score but also make paying back dues manageable. So, if you have a credit limit of ₹3 lakh a month, make sure to not take on a loan of more than ₹90,000 in a month unless there is an emergency.
- Check your credit report regularly
Your credit report is what every lender first checks when you apply for any type of loan. It includes your credit history and credit score, and helps lenders determine your creditworthiness. It is essential to regularly check your credit report so that you are aware of your credit score, and to identify any errors that need to be rectified. A high credit score and good credit history can not only increase your eligibility for loans in the future, but also get you attractive interest rates, reducing your overall interest burden.
It might not always be practical to remain debt-free, since certain types of loans, such as home loans, are needed to meet financial milestones. Nevertheless, you can remain stress-free with effective debt management.
In addition to the strategies and tips mentioned above, another important step you can take before you take on any type of debt is using online financial tools like EMI calculators and loan eligibility calculators. These tools allow you to get an idea of what your EMI obligation could look like before you apply for the loan. Lastly, if you are finding managing debt tricky despite these strategies, you can consider consulting a financial expert who can help you come up with a debt repayment strategy tailored to your financial situation.