“Chains of habit are too light to be felt until they are too heavy to be broken.” ~ Warren Buffett
South Africans are in love with debt, or at least that's what their outstanding debt indicates. The South African Reserve Bank (SARB) announced in its quarterly bulletin that household debt as percentage of disposable income was 72.5% in the first quarter of 2019. That means almost three quarters of a consumers’ income goes towards servicing debt. Millennials, born between 1981 and 1996, have also accumulated excessive amounts of debt. The 2017/2018 Millennials Survey revealed that 64% of millennials – compared to 14% among older generations – had a personal loan and 35% of their income was spent on servicing just the interest on debt. Not only is this debt hindering with millennials' ability to create long-term wealth, but it is adding to their financial stress as well. Here are the most effective methods for debt management and reducing debt.
Under the Snowball Approach of debt management, you should pay off the smallest loan in your debt portfolio first. The primary intent behind the snowball approach is to provide borrowers with a psychological advantage in debt repayment. Since you start on a winning note, you're likely to stay motivated towards achieving complete freedom from debt.
What you need to do:
Prepare a list of your loans.
Rank them in ascending order, listing the smallest loan first and the largest one last.
Pay off the smallest loan first and continue paying off debts from smallest to largest.
Pros & cons
The snowball approach provides a psychological edge, but it's not the most efficient method of debt repayment. You may continue incurring high interest charges on other expensive loans.
The Avalanche Approach uses a financially-sound strategy, requiring the borrower to repay loans with the highest rate of interest first. Under this approach, you should take all of your available cash (after paying the minimum repayments on all other loans) and dedicate it to the loan with the highest interest rate. The avalanche approach helps you save hundreds of Rands in interest charges throughout your debt repayment cycle.
What you need to do
Create a list of all of your loans.
Rank them in descending order, putting the loans with the highest interest rate at the top and one with the lowest rate at the bottom.
Start using all of your excess disposable income to repay the loan with the highest rate of interest.
Pros & cons
While the avalanche approach is a better debt repayment strategy, it does require one to stay consistent in making repayments. If the first loan has a higher balance, it will take longer to clear. Without the quick gratification of paying off a debt, you might feel discouraged and stop your debt repayments.
The Bottom Line
Getting out of debt might seem like a distant dream but do understand that there is always a way out. It will require sacrifice and probably a few less trips to “secret locations”. The key however is to stay consistent with your repayment efforts and practice financial restraint while attaining your financial freedom.