We have repeatedly talked about the importance of saving and various methods of saving. But what if we are in debt? Debts become the antithesis of savings, the opposite situation. Not only have we not been able to save some money, but we have borrowed to meet various expenses or investments.
Types of debt
Undoubtedly, not all debts are the same, nor do all loans have the same conditions. In some cases, indebtedness is more unavoidable (although it is not mandatory), while in other situations, it could be avoided.
For example, many people acquire a home through a mortgage, because it would be very difficult to save all the money needed to buy it. And that does not mean that they are not able to save part of their current income. The same can happen in the case of buying a vehicle. Although in this case, it would be more feasible to save beforehand, the truth is that most people do not, because the amount of the purchase of the car can be around – as an approximation – what they earn in a year.
But there are also debts linked to consumption, leisure, payments made with the card and then financed, and so on; a wide variety of loans, which can cause us to not be able to save, since the money we have left over we have to dedicate to the payment of these debts and their interests (in many cases, quite high).
What would have been desirable would have been the opposite situation, which we would have saved first and then we could spend. Seen from this point of view, indebtedness is produced by spending what we do not have, when the opposite would be preferable, the pre-saving. But, once we have borrowed, how can we deal in the best way with the payment of debts?
Methods to pay debts
There are different systems to deal with the payment of debts. It is advisable to do a previous job, making a list of all the debts we have, the terms, interest rates, fees we pay, and so on. Having this list, if possible in spreadsheet format, will allow us to get a clear idea of the situation: how much we owe, how much we are dedicating monthly to satisfy the credits, how much we need to finish, and so on . For example:
It is also convenient to make a budget of expenses, to see what we are spending the money, and what we can reduce, to save. And it is that an important part of the plan to reduce debts is to see what additional money we can devote to the repayment of these.
In the example, this person dedicates 1,300 dollars per month to the payment of fees. This is the minimum you are going to devote to your debts, but if you want to significantly reduce the burden you are supposed to, you should dedicate an additional amount. Suppose that, after analyzing your expenses, cut 150 dollars per month in unnecessary items.
From there, two basic methods can be followed:
1) Reduce the most burdensome debts first
As you can easily see in the table, some debts are more expensive than others. According to this, we would dedicate the extra 150 dollars to pay off the credit card debt, which is the most burdensome, since it has an interest rate of 12%.
Instead of taking 7 months to pay it off, since it has 1,400 dollars left and pays 200 a month, it would only take 4, since it would be paying 350 monthly (for the sake of simplifying the calculations, in this example we don ‘ t consider the reduction of interests that would entail the advancement of payments).
Then, once he finished paying this debt, he would have 350 dollars per month free to dedicate to the next most expensive one, which is the consumer loan. Instead of taking 8 months, it would pay off in just over two, and it would have 500 dollars available for the next loan, and so on.
2) Snowball method
In this method, the approach is similar to the previous one, but instead of paying the debts from more expensive to cheaper, they are paying off from a smaller amount to a greater amount. This is done because it is easier to get rid of smaller ones, and thus the person’s effort to save is psychologically reinforced, since he sees that he quickly gets rid of some debts.
In this case, we would start with the consumer loan, which is the one with the least amount alive to pay. Again, as in the previous case, once this debt was settled, we would concentrate our efforts on the next one, in this case, that of the credit card, and so on until all were settled.
Benefits of paying debts
As we pay off debts, we not only spend less money on interest, but we have more available balance.
For example, in both cases, when the payment of the car is reached, the debts of the consumer loan and the card have already been satisfied, and 800 dollars per month are available for the payment of the car: the 150 we save + 150 of the consumer loan + 200 of the credit card loan + 300 of the car loan. With which, instead of paying the car in five years, we can finish paying it in a year and a half.