I want to get out of debt, where do I start?
It is not necessary to fall into over-indebtedness to devise a debt repayment plan. So if you have already calculated your level of indebtedness and aware of the limit of what is healthy or has already exceeded it, do not leave too much time to act.
First of all, there is no magic formula that can or should be applied to all cases of indebtedness, each one of them is different and must be assessed separately.
Sometimes it is recommended to start with the small debts and then attack the big ones. But this recipe would not be addressing the root of the problem and would not provide real relief. It is not recommended to rely on the globally applied method known as “snowball”, unless all your debts cost more or less the same. Let me explain better:
The “snowball” method would mandate to eliminate the smallest debt first. And once paid, use that available money to attack the second smallest and so on until you reach the largest. But, in this case, if the smallest one is a loan whose installment and interest rate are fixed, plus the rate is the lowest of all the debts. Then, it is not a debt that is going to grow or threaten your financial stability.
What you should do?
Here are several things to consider before deciding where to start.
1) Make an inventory of debts
The first thing to do is to be clear about the situation. But this does not only mean listing how much you owe, but also detailing the amount of the debt, the annual and monthly interest rate and the installment or payment. Once we have a clear picture, it will be easier to identify where to start.
2) Assess the situation
The problem may not necessarily be the amount of the debt, but what its payment implies for us and how much it costs us. For example: it is not the same to owe $10,000 for a mortgage loan – which pays an annual interest rate of no more than 10% (0.8% monthly) – than to owe them to credit cards, whose rates reach up to 50% annually (4.16% monthly).
Above all, you should identify, if you want to get out of debt because the payments are already impossible. Or if you simply want to pay less interest and in a shorter term, but the installments do not compromise your budget.
If your case is the first one, the priority should be to reduce the most expensive credits, those for which you pay high interests. Why? Because as those debts begin to shrink, as they are so expensive, you will quickly feel the relief and pay less.
3) Analyze your budget conscientiously
If you are not clear about how much you can really afford to pay, you will hardly be able to make a good decision. Here it is necessary to formulate an austere budget, so that you can allocate as much as possible to debt repayment.
Why this is recommended?
Because it would be useless to allocate 90% of your income to pay debts if with the remaining 10% you will not be able to cover basic expenses and you will have to resort to more debts to do so. If you do not know how to make a budget that you can really meet, check out this article.
4) Review the guarantees and risks
Regardless of whether the debt is with a bank or a lender, you should also weigh what guarantees were given for that credit. Whether someone signed as a guarantor, if the house was used as collateral or if the collateral is your salary, you should weigh what would happen if the debt becomes unpayable and based on that, you should think about the decision.
A loan between individuals agreed verbally will not represent the same risk as one that involves a wage garnishment. And if one of your debts is for a basic service such as electricity or water, or if you are behind on your house payments, you should make it a priority because of the serious implications of non-payment.
5) Indicate if you can make changes in those debts
For example, if you have several maxed-out credit cards and are struggling to make the minimum payments, it is healthier to take out a personal loan or refinance (at rates that are usually half those of the cards). Yes, in the end you will unfortunately owe the same or a little more, but with other payment conditions that could free up important sums of money from your income (and you will pay less interest).
6) Don’t keep getting into debt!
This is the most important point of all. If you are determined to pay off your debts and avoid a calamitous situation, you must stop acquiring more debts or it will be a circle from which you will not be able to get out. Instead, it is time to look for additional sources of income, such as selling some belongings or looking for an extra job.
Have you decided where you are going to start eliminating debts?
I am Nikesh Mehta, owner and writer of this site.
I’m an analytics and digital marketing professional and also love writing on finance and technology industry during my spare time. I’ve done online course in Financial Markets and Investment Strategy from Indian School of Business. I can be reached at [email protected] or LinkedIn profile.