Methods of managing debt
To illustrate the methods on how debt can be managed I helped my anonymous and imaginary friend, Debtor, to get on the path to being free of debt.
Debtor John Paul found me several weeks ago requesting outside independent assistance in assembling a debt plan that will effectively accelerate the entire process of having to pay off three debt accounts he has piled up
- Two credit cards
- A car loan loan on the verge of defaulting
- A massive balance from the healthcare procedure from the year before
Said Debtor has been trying frantically to pay off the balances, but was falling behind because of a mix of high rates of interest and enormous debt balances.
After saying yes to assist with his efforts, I proceeded to utilise him on the initial step to add up all his debt balances directly into one centralised spreadsheet. This spreadsheet consists information he needed about each debt account, including balance, APR, monthly minimum payment, and payment dates.
Getting finished collecting his financial obligations, it finally had been time for debtor John Paul to go to step two of the process, finalising his free of debt plan of action.
How you can prioritise your financial payback
There are really three main thoughts based on how people should go about prioritising to pay off their debt. All are pointed out in the list below:
Debt Snowball Method
The debt payback method that’s, for me, most widely used within the personal finance blog sphere (maybe because of the appealing “ring” it posesses) is debt snowballing.
Essentially, this method involves restructuring your financial obligations to ensure that you have to pay just the minimum needed to any debt accounts, apart from the one with the lowest balance. After this you commit as much money as you can to pay off the lowest debt balance as rapidly as you possibly are able to.
Advantage = It provides the debtor the mental advantage of seeing the amount of their debt accounts decrease rapidly.
Disadvantage = This method also costs you as much as possible because when you are seeing the amount of debt accounts you’ve decrease, you can nonetheless having to pay out considerable amounts of cash on greater interest rates.
For instance, for those who have a car loan (5% interest) balance of £500 along with a credit card balance of £10,000 (28% interest), your debt snowball method dictates that you’d repay the car loan first, despite the fact that the credit card debt might be costing you 100s of pounds in interest.
DOLP (Done On Last Payment Method)
The proprietary DOLP technique is the premise of David Bach’s Debt Free For Life book. It involves setting each debt account a DOLP number.
DOLP number = balance outstanding/minimum payment
After setting the DOLP number for each of the debt accounts, you only pay the minimum payment for each account except the one with the lowest DOLP number.
IMHO, this process is nice since it takes into consideration both mental advantage of having paying off a little balance rapidly and also the effect of interest rates on minimum payments.
Pay off the greatest interest rate balance first
- This method is really easy since you only pay the minimum payment needed on every debt account apart from the main one with the greatest rate of interest, where you pay as much as you can.
- It is my personal favourite because this method saves you as much as possible. Can you explain that? This because of the fact that with this particular method, you’ll be eliminating your (most pricey) highest rate of interest account first.
- So, as you might have guessed, the “paying off the highest rate of interest account first” approach was the one which Debtor and that I opted for.
The technique used
To finalise the debt free plan of action, Debtor and I created his “collect your financial obligations” spreadsheet and sorted it from greatest to lowest APR. Then we changed the planned obligations to ensure that he would only pay the minimums for those accounts aside from the main one using the highest APR.
For that greatest APR, the new payment plan moving forward would be: Total amount he’s presently having to pay monthly for all his debt accounts minus the amount of the minimum obligations for the lower APR accounts. Simple approach, no room for excuses and very effective.
What is a debt consolidation
In several conditions, people get in way over their heads and take on excessive amounts of debt. These debtors require a method of getting away from their financial bad dreams. This is where debt consolidation loans come up. They’re a tool that lots of debtors use to ensure that they are able to avoid facing personal bankruptcy.
Benefits of Debt Consolidation Reduction Financial loans
Just what is a debt consolidation loan? A debt consolidation happens when a customer takes out one big loan and uses it to repay a lot of smaller loans. It’s a good way to consolidate bills. Debt consolidation reduction programs are best when confronted with high rate of interest debt.
The main benefit of a debt consolidation reduction loan is that it can help to save the clients money. A customer may take out a loan at a lower rate of interest and reduce total interest obligations. For instance, if a customer had one credit card balance at 15% and the other at 22%, he / she might consolidate these outgoings with a loan at 7% and save straight away through interest savings alone.
An additional fact is that the consolidation of financial obligations reduces the amount of bills the customer needs to pay every month. This decreases clutter and saves the customer the headache of needing to mail off a lot of bills every month. The customer only needs to be worried about making one payment per month to pay for the lump sum of their debts. A disorganised customer is not as likely to overlook one payment instead of coping with 5 or 6 obligations.
For occasions when a person reaches their wits and requires a strategy to their debt worries, a debt consolidation reduction loan might be a choice. The consolidation of financial obligations can provide another chance to customers as well as financial stability and lower total number of financial obligations.
Clearly, you will find a variety of routes that can be taken to manage your financial troubles. These are varying from simply organising your debt payback plan intended to maximise effectiveness (as talked about above) to more direct approaches of debt consolidation reduction and counselling (when the debtor is at risk of personal bankruptcy).
However, as with many situations in life, the bottom line is to determine which strategy matches your finances and personality profile best.