Managing multiple debts or even a single colossal debt well can be considered a skill. We have to admit that not all of us are blessed with that skill, to begin with. However, it is never too late to learn anything and adapt it to our lives to make things easier.
Though there are many types of debts available in the market, youngsters are falling prey for the shopaholic outlook with the easy availability of credit cards during the recent past. It is observed that individuals spend heavily on credit cards and then choose only to fulfil the minimum payment amount. In other words, the actual issue keeps on getting postponed until it builds up to be a huge debt that is tough to repay.
You may be in credit card debt or have been repaying any other kind of loans such as education loan, home loan, wedding loan, or anything for that matter. Here is a logic-based approach to viewing your debts in a new light and getting at it.
What is a debt snowball strategy?
Here’s a small experiment although you can’t perform this in Indian weather! When you make a small snowball and let it slide on the snow, the ball gets bigger and bigger over the path. This analogy is applied to debts to tackle them effectively.
The basic concept of the debt snowball method states that individuals with multiple debts must sort them by outstanding balance and pay them off, starting from the smallest to largest. The individual is advised to pay the minimum repayment amount to all the debts and target the maximum repayment towards the smallest debt first based on the budget available for repayments.
This approach gets you off the smallest debt soon, i.e. reducing one debt from the set. Going forward, you will be able to get rid of debts at calculated intervals. Meanwhile, you will still be fulfilling the commitment towards all the debts you owe.
Also Read: Four loans you can opt for to battle financial stress during COVID-19
Illustration to explain the debt snowball method
Consider Ms A had a mortgage loan of Rs.5 lakh and a gold loan of Rs.80,000. The minimum monthly repayment for the former was Rs.7,000 as this is a long-term loan and Rs.1,000 for the latter. Since she could afford to pay Rs.10,000 towards debts, she started paying Rs.7,000 towards the mortgage loan and Rs.3,000 towards the gold loan.
In almost three years, she could clear the gold loan. Now that she has cleared the smallest debt first, all of her budget, Rs.10,000, can be dedicated towards the mortgage loan and pay it off before the scheduled tenure.
On the flip side…
You can apply the snowball strategy not only to debts but to savings as well. Just list out your savings and investment goals on a piece of paper. Next, set up your own rules on the minimum monthly payment you can afford towards each of the savings and investment buckets you have listed down. Do not forget to focus a bit extra on your primary goal among the listed buckets.
Say, you want to have an emergency fund of Rs.2 lakh, put aside Rs.1 lakh to fund for your wedding, and a downpayment of Rs.50,000 to buy a car. In this list, your primary focus will be on securing downpayment for the car. Consider that you set aside Rs.5,000 towards each of the buckets listed. Your downpayment for the car will be ready in 10 months.
After this period, you will be left with two buckets and the same Rs.15,000 budget. You would have come halfway through arranging your wedding fund and one-fourth through the emergency fund. Now, please focus on the wedding fund and spare Rs.10,000 towards it and the usual Rs.5,000 towards the emergency fund. The wedding fund will be ready in another five months. Then, you can spare all your budget towards the emergency fund.
We hope that you get more strength to deal with your debts and finances, especially during this time of the pandemic that has flipped our lives. Also, the pandemic has taught us how vital emergency funds can be. Utilise the snowball concept and deal with your finances well!
For any clarifications/feedback on the topic, please contact the writer at apoorva.n@cleartax.in
