Taking a debt is not always a bad thing. It might actually be a smart option in some cases but whether to take a loan or not is a debate for another time. Right now you are reading this article because you are in debt and want to get out of it in the best possible way. First and foremost I would like to say that you should not try to jump on quick ways to repay loan. Slow and steady is the only out of debt.
Table of Contents
Step 1: No More Debt
The last thing you want to do when trying to get off debt is taking more debt, no matter how small it is. There is a cost involved in borrowing. Even though it may seem like a small expense, you might actually be spending a lot more. Let us take a look at all the costs that you actually pay:
- Principal amount
- Interest amount
- Inflation
- Depreciation
Let’s say you want to buy a phone that costs Rs. 50,000, by the end your payment you would have paid nearly Rs. 58,000 for it (14%, 24 months). Plus resale value would have reduced significantly by the end of two years.
This includes stop spending on credit card. Let’s not forget that credit cards are also nothing but small loan that you take for short duration.
Step 2: Assess Debts
Make a note of all the debts that you have. You can make table with three columns with the type of debt, EMI and interest rate. A sample table is below:
| S. No. | Type of Debt | Principal | EMI | Interest Rate |
| 1 | Friends and Family | 10,000 | Discretionary | Discretionary |
| 2 | House Loan | 80,00,000 | 70,000 | 8.5% |
| 3 | Phone | 50,000 | 2,500 | 14% |
| 4 | Education Loan | 12,00,000 | 11,500 | 10% |
Step 3: Record Expenses
To have a clear plan for repaying the debts, you first need to know exactly where you are spending your money. You can create a Google sheet or use an app to record all your expenses. Once you have your expenses tracked, it is easier to figure where you can save money to repay higher loan.
Related Post: Monthly Budget Planning for Beginners With Proven Tips
Step 4: Invest or Repay?
Now that you know how how much you owe and how much you will be able to save, it is time to make next decision. A very natural question that you may have next is why should you repay loan when you can invest it? The answer to this question is very simple.
Scenario 1: Return on invest < Loan interest rate
Repay the loan
Scenario 2: Return on invest > Loan interest rate
Invest your money
In reality, it does get more complicated than this simple equation. For example if you plan on investing in stock market, there is a lot of variability and you won’t know for sure how much return you will get. In such cases of relatively risky investment, I would personally recommend going for repayment of loan over investing.
Step 5: Strategise
The primary rule of loan repayment is to pay minimum EMI due for each debt that you owe every month. Any extra savings that you have that you can be used to invest or repay as decided in the previous step. If you decide to repay, you need to strategise which loan you should repay first. There are two strategies that you can look at:
- Snowball
In both the methods, you pay minimum EMI for all the debts. In this method, you tackle the smallest loan first. Paying off the smallest debt can help you build momentum. In our sample loan table in step 2, it would mean repaying friends and family first. - Avalanche
Here you prioritise paying loan that has highest interest rate. In the sample table that we saw in step 2, it would mean paying phone loan first. Mathematically and logically, this is the method you should go for as it will save you money in the long run.
Conclusion
You can easily get overwhelmed when you have debt to pay but once you have a clear plan backed by logical reasoning for decisions that you take, it becomes easier. You will be able to see the finish line of the day you will be debt free and most of your earings.
