Do you know how to get out of debt on your own in a fast way ? If not, read on to find out how. Debt can come in many forms – home loans, personal loans, credit card debts – all of these can put your financial planning in a disarray if not handled in the right manner.
Reducing your debt not only frees up more money for investments but it also ensures you become financial free with your life.
Read on to find out about one approach on how to get out of debt on your own terms quickly.
Stop taking more (bad) loans
This is your first step to get out of debt on your own – avoid fresh trouble.
This is a no brainer. If you are already loaded with loans, why would you want to acquire more of them and make your life more difficult ? Ask yourself how many loans can I have before taking any more.
Remember there are good loans and bad loans. Good loans are those that help you build an asset over your lifetime – say a home loan. Bad loans are those which are expensive and funding products that depreciate over a period of time – say an iphone bought on your credit card. You need to necessarily avoid bad loans and look to see whether the good ones can be serviced by your income.
You need to stop buying anything on credit cards and personal loans. If you have the money to buy the product with full down-payment, then go for it. If not, avoid buying the product.
Better still, you might want to check whether the product you are after justifies your needs and wants and whether you can live without it. It would be best if you can avoid spending on it and save the money to get out of debt you have.
Build a strategy to get out of debt/loans – the Debt Snowball effect
Suppose you have many loans. How would you get out of all the debts on your own ? Or would you continue paying the minimum each month (called the Equated Monthly Installment – EMI) for all of them till you were asked to ? Well, there is a better strategy.
- List out all the loans you have one by one.
- Sort them according to the balance left to be paid off – lowest to highest.
- Pay the Equated Monthly Installments (EMIs) on all of them.
- But at the same time, pay off more than the EMI towards the first one in the list – the one with the lowest balance.
- Keep doing this till the first loan with the lowest balance is cleared off.
- Repeat the process with the outstanding loans you have.
Here is the process in a figure on how to get out of debt:
Let us see how this will work with an example. Adi has the following 3 loans. How can he get out of debt quickly ?
- A credit card loan with outstanding balance of Rs 5 lakhs at 40% rate of interest.
- Another credit card debt of Rs 1 lakh at 30% rate of interest.
- A personal loan with a balance of Rs 4 lakh with 20% rate on interest.
What would you suggest Adi to clear off first ? If you think for a moment, you will be tempted to say that Adi needs to clear the first one first as it demands a higher rate of interest. That is a fair inference but in this case, the outstanding balance is huge. That means that Adi needs to plan to save and invest money so that sometime in the future he could get out of debt. Would Adi or you wait that long ?
Let’s think in another way. Sort the above three loans with the balances starting from lowest to highest. This is how it will look.
- Another credit card debt of Rs 1 lakh at 30% rate of interest.
- A personal loan with a balance of Rs 4 lakh with 20% rate on interest.
- A credit card loan with outstanding balance of Rs 5 lakhs at 40% rate of interest.
Now all Adi needs to do is pay off the EMIs for all 3 loans and then throw in more money towards clearing off the first. So for example, if he had Rs 30,000/- with him to spare after all his expenses, he should simply pay that towards reducing the principal on the first one. This is called part paying the loan. That way the balance on the loan is reduced. Adi will keep doing this till the balance is zero which is when the loan is cleared – he has then got out of debt on his own terms.
Of course, we have assumed here that the loans you have will allow for this pre payment option. In case they don’t, your alternative is to save for the balance over a period of time and then clear off the loan or to switch to a loan with a lesser rate of interest.
The above strategy is loosely related to the Debt Snowball effect and is very famous in the Western countries. It has been used very effectively by financial gurus to prove that it works.
Do you think this will work in your case, if not, why ? Do you know of any other way you can help someone get out of debt quickly ?
Good idea.
I think clearing off any loan will physologically be very beenficial and starting with the lowest can be a small stepping stone for the person. I think it is most beneficial if the largest loan is cleared off first but then something is better than nothing.
@Sanjiv, In a way you are right. The biggest loan off your back is a huge achievement.
Very good.
Question is also – Should we start re-paying more EMI plus “Throwing more money” on the loans – which has more interest rates?
@Anand, Yes Anand, irrespective of the interest rates, If you think you have bought a loan towards a non-asset and want to close the loan as soon as possible, it makes absolute sense to pre-close the loan by ‘Throwing more money’ as and when you get it.
@Manickkam, Close off these dud loans otherwise it’s a disaster waiting to happen.
@Anand, Some quantitative analysis might help here. Have you tried that ?
@Anand,
As the interest rates are peaked very high, it would be good to repay some of the loans if you have surplus funds. Looks like interest rates would correct in the second quarter.
Rakesh
Radhey,
I just have a different opinion here. Instead of paying the debt which is less and which may have less interest rate, if pre-payment is allowed and if there are no pre-payment charges, it makes absolute sense to start pre-closing the ones with high interest rates.
This will reduce the amount of cashflow being spent on loan front even though the number of loans remain the same, which is what should be his cause of concern more.
@Manickkam, I think it is case to case basis and needs to be calculated to ascertain whether it is going to result in some gains at all. One cannot and should not blindly go with such decisions – the above points are to be used after doing due diligence.
I agree if we have surplus funds and there are no pre-payment charges it would make sense to pay off your loans. I will share my experience. I had my ongoing home loan. I did some consultancy work for which i got paid. Instead of keeping it in the bank for 5% Savings or 9% FD, I thought it would make sense to pay of part of my home loan where i am paying interest at 11%.
Rakesh
@Rakesh, That is the right way to do it !
Respected Sir,
I have taken hdfc bank personal loan for Rs. 129000. Tenure is 36 months.
I have completed 34 months emi. Anyhow all the months I have paid the emi in late payment, fine and cheque bonus charges due to my financial problem.
Last 2 months emi I have not paid due to my family personal problem. It was already 4 months over. But till I have not paid and also. Now planned to repayment the 2 months due with fine or penalty in coming month first week. So it comes 15 days time frame. Anyhow I will pay the amount in next month at any cost. But now the hdfc bank collection centre sent an sms to my official number as that they are coming to my work organisation to collect the money.
For last 4 months the hdfc bank collection centre calling on my official number and not on my personal number. My personal number is not allowed inside the company as I am working in Pharma Company. I couldn’t able attend their call for past days because my work area & work hours is like that.
But for me if they come here my career will get damage. And also I am a low depression person and don’t know how to overcome this problem
So please kindly advice me how to overcome this problem. Anyhow I will pay the amount in the next month.