Loans can be useful under certain conditions, to meet unforeseen expenses and life projects. But if you are not careful, and you live on loans, they will keep compounding, and thus find yourself in debt.
And being in debt is not an easy situation: between the various reminders from creditors and even sometimes court letters.
If you’ve found yourself in a log of debts, don’t feel alone. There are strategies to pay off debts quickly and easily.
The first thing in getting out of your debts to earn financial freedom is taking the bull by the horns. That is, you must be fierce and ready to confront this situation. Also, you must know that there is no magical formula anywhere…
In this article, I’ll be taking you through a common technique: the snowball method. This method often pops up in articles about paying off debts. Below I explain step-by-step how this method works.
How to pay off debt
Here are steps to pay off your debts:
Step 1: Understand the principle of good and bad debts
Not all debts need to be repaid: only bad debts do. Bad debt is a debt contracted (for example, consumer credit) to buy a property that loses value and does not bring in money. Example: car, smartphone, high-tech equipment, marriage…
Good debt is a debt contracted to buy an investment(real estate for instance) that brings in more money than the cost of purchase. Now that you have understood that, you will focus on repaying bad debts.
Step 2: Build up precautionary savings
Before considering repaying your debts, you must first build up precautionary savings. These precautionary savings will allow you not to dig deeper into your debts. This money is there in the event of a hard blow: divorce, unforeseen expenses, home repairs, etc.
If you use all your money to pay off debts without setting aside precautionary savings you can make your situation even worse. With this type of savings, you are calm when a sudden need arises and doesn’t add to the already existing pressure of paying off your debts.
Ideally, precautionary savings should be equal to your 3 to 6 months’ salary/income. This means that you can live for 3 to 6 months if you do not receive a salary/income.
Let’s imagine that your salary is N100, 000: you should therefore have a minimum of N300,000 aside, and you can even go up to N600,000. The savings should be placed in an account where you can quickly withdraw the funds in the event of an unforeseen expense. Once the precautionary savings have been built up, you can repay your debts.
Step 3: Calculate your fixed expenses and find a way to increase your repayment capacity
To be able to repay your debts quickly, you will have to find a way to increase your repayment capacity by increasing your current income. For this, you can consider taking a second job for a while and/or selling items that you have at home and that you no longer use such as books, furniture, toys, etc.
Also, to increase your repayment capacity, calculate your fixed expenses for the month. The objective here is to reduce or even eliminate certain non-essential expenses to allow repay your debts more quickly.
Step 4: Write down all your debts and analyze your debt ratio
In an Excel file, write down all your debts and income, including the following information:
- credit organization;
- total amount to be reimbursed;
- credit end date;
- monthly loan payment;
- type of credit;
- reason for credit;
- interest rate ;
- household income;
- debt ratio.
The debt ratio is one of the best-known criteria used by banks to decide whether to lend you money and minimize their risk of default. Indeed, a bank will not finance you if you exceed 33 to 35% (depending on the bank) debt ratio.
Why? Because they think that beyond this percentage, there is a risk that you will not repay the loan because you also have other debts to pay.
If the bank applies this rate, it is not without reason… This allows you to continue to live decently and to be able to repay your loan every month!
You must think like the bank too and ensure that all of your credit loans do not exceed a maximum of 35% of your net income for a year. The lower your debt ratio, the better! The higher it is, the more you risk being in debt.
Putting all your debts on paper or Excel file will give you an overview of the total amount you still have to repay and the payments for each month. You can then use the snowball method to pay off your debts quickly.
Step 5: The Snowball Method
Now that you have noted all your debts on paper or Excel file, you will then tackle the repayment of these debts using the snowball method. The method was popularized by a famous personal finance coach named Dave Ramsey.
To apply the snowball technique, you can follow the steps below:
- Order your debts from smallest to largest.
- Assign an amount of money per month to pay each of them
- Pay the minimum for each debt except the smallest of all. For the smallest debt, pay a little more than the minimum to pay it off as quickly as possible.
- Any money you have available, use it to continue paying the one with the least balance.
- When that debt is gone, continue paying the other debts with the same amount and dedicate more of your money to the one with the least balance, and so on until you run out of debt.
At first, it will be hard… but once you have repaid your first debts, your repayment capacity will be greater and greater and you will therefore be able to repay your following debts more quickly.
If you have two similar debts, with an almost identical amount remaining to be repaid, repay the one with the smallest monthly payment first. Always stick to the principle of repaying the smallest debt first.
Financial Freedom: Solutions to avoid falling into debts again
Going forward, here are the questions you should ask yourself before taking out new debt:
- Is it good debt?
- Do I really need this latest trendy high-tech gadget?
- Can I wait a few months to make this expense?
- Does the property I am going to buy lose its value over time?
- In how long do I have to finance this project?
- Is it a real need or a new fad?
By answering these questions, you will give up taking out new credit 99% of the time! Indeed, you will realize that you do not necessarily need the item you want to buy.
Some life projects still require money: marriage, work, etc. However, by postponing the projects, you have time to save money. For instance, you can postpone your wedding if you can’t afford it now so that you can have more time to save for it.
For home renovation works, you can start by doing only one room rather than a total renovation. Do it little by little!
Also, everything high-tech should not be bought on credit, these are goods that lose value and go out of fashion quickly.
Here are the different steps to pay off your debts quickly:
step 1: understand the principle of good and bad debts
step 2: build up precautionary savings;
step 3: calculate your fixed expenses and find a way to increase your repayment capacity;
step 3: analyze your debt situation;
step 4: use the snowball method to repay debts more quickly.
I hope this information is helpful. If it does, let us know.