Debt is an easy trap to fall into and a difficult place to escape from. If you have accumulated debt across a number of credit cards and shop accounts, it is strongly advised that you embark on a debt reduction strategy to eliminate your unsecured debt. While you are servicing high-interest, unsecured debt, it is almost impossible to start saving, build an emergency fund and invest for the long-term.
Here are some tips to reducing and ultimately eliminating debt:
- Stop shopping. Although this won’t get you out of debt, it is the first step to ensuring that the situation doesn’t deteriorate any further. It’s almost impossible to make a dent in your debt if you continue spending. Whether you cut up your credit cards, freeze them or lock them in the safe, put mechanisms in place to ensure that you aren’t tempted into further spending.
- Make a list of all your loans, debts and account information, together with the applicable interest rates and payment periods.
- Prepare a detailed monthly budget which takes into account all your hidden costs such as parking fees, tips, coffee on-the-run, Uber rides and convenience meals. Work out a way to reduce your monthly expenditure by at least 10%. In order to do this, you may need to be ruthless. Consider ways to reduce expenses such as DStv, monthly subscriptions and gym membership by downgrading to smaller bouquets or packages.
- Use a debt-reduction calculator to work out a payment plan that works for you. There are plenty of free online debt-reduction calculators available to choose from. Enter all your debt information and allow the software to calculate a payment plan that works for you. (See below for more information on the snowball versus avalanche approach to debt reduction.)
- Even if you’re not a hoarder, the chances are that you have stuff you can sell for cash. Every cent really does count, so make a concerted effort to sell anything you no longer use. Use the cash to make lump sum payments towards paying off your debt.
- Make more money. This is easier said than done and may require some creative thinking. Apart from negotiating an increase with your employer, consider monetising your hobby, waitering, doing promotional work after hours and on weekends, or tutoring. The gig economy is perfect for generating after-hours income.
- Use any bonuses or tax refunds to settle debt. Do not be tempted to spend any financial windfalls on buying more stuff. Remember, this way of life is not forever. You are merely employing a short-term strategy to get yourself out of debt and on a path to financial freedom.
- Celebrate small successes along the way. As and when you pay off a debt, don’t be afraid to reward yourself for achieving a goal.
- Once you have paid off an account, close it and commit to using cash only in the future.
- Once you have settled all your debt, start channelling your money towards building an emergency fund of between three- and six-months’ worth of income.
It is important to understand the difference between ‘good debt’ and ‘bad debt’. Good debt, such as a low-interest student loan or home loan, is debt that is required in order to pay for big-ticket items that one would not otherwise be able to afford.
Borrowing money to buy a modest home or to further your education is considered good debt.
However, debt that is incurred to purchase new vehicles, clothes, consumables and other goods and services is generally expensive debt (high interest) which is not sustainable in the long-term.
When choosing a debt reduction strategy, there are two main approaches you can consider:
Snowball approach: This method involves paying off the lowest balances first in order to give you some ‘quick wins’ early on in your debt reduction plan. Paying off one small debt quickly will give you some momentum early on that may keep you encouraged and motivated. The main benefit of this approach is the psychological effect of seeing a number of small debts being paid off early on. The downside is that this method may end up being more expensive as you are not necessarily paying off your most expensive debt first.
Avalanche approach: This approach involves paying off the debt with the highest interest first. It may take longer to see your first loan completely paid off, but it is the cheapest way of eliminating debt. The best way to tackle this is to rank your debt from the highest to lowest interest and start tackling the most expensive debt first. This will result in you emerging from your debt sooner and paying the least amount of interest possible.