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Before knowing to overcome debt, one needs to know what debt is, the types of debts and how one gets into debt. Debts are a liability that needs to be cleared off as quickly as possible to avoid the accumulation of more interest charges over time.
A person gets into debt by borrowing money from an individual or a firm for example; student loans, mortgages, car loans, home loans, etc. Taking on more debts than you can pay can lead you into a Debt Trap.
Source: CNBC
Types of debts
Secured Debt:
Secured debt is a debt that is taken by putting up collateral. That way the debt is secured. If you fail to pay the required amount, the lender can use the collateral as a payment for the outstanding amount.
If the collateral does not satisfy the recovery amount the lender may go after you in court to get the remaining amount.
Unsecured Debt:
As the same says, there is no collateral in unsecured debt, instead the creditor lets you borrow money based on your ability to repay the debt.
Some of the most common types of unsecured debts are Credit Cards, Personal loans, student loans, medical bills, etc. Since there is no collateral on the line the lender cannot repossess any of your assets. However, if you fail to pay for too long, the lender may report your outstanding payments to credit bureaus & may seek a court judgment against you.
Revolving Debt:
Revolving debt can be secured or unsecured. Credit cards are the best example of unsecured revolving debt. A Personal Line of Credit is an example of secured revolving debt.
Revolving credit allows you to continuously borrow up to the credit limit. As you make purchases, your credit line gets smaller; as you make payments, it gets bigger. Based on the debt, the minimum payment amounts due each month keep on changing.
Installment Debt
Another name for non-revolving debt is an installment loan. An installment loan offers a big sum of cash at the beginning of the loan.
To consolidate debt, for instance, you might get a personal loan for $10,000. You make a fixed monthly payment (say, $300) that is spread out over a predetermined time (like 36 months). The most common types of installment loans are Mortgages, Auto Loans, Student Loans, and Personal Loans.
Debt strategies
Prioritizing Debts:
Make a journal for the debt that is owed and list the interest rate, minimum payment & due date under each debt. This way you can prioritize the debts you want to tackle.
Debt Snowball Strategy:
Create a list of debts in increasing order of balance amount regardless of the interest rates i.e. paying off the debts with the lower balance first and then move to the debts with a larger balance.
The benefits of the snowball strategy are that it gives you an emotional & psychological boost. Clearing balances quickly motivates you to push harder & releases the amount of stress on yourself.
Debt Avalanche Strategy:
In this strategy instead of ordering your debts from smallest to largest balance, instead, order your debts in decreasing order of interest rates. Payoff the debts with higher interest rates first, then move to those with lower interest rates.
The avalanche strategy will help in reducing the risk of paying more overall interest in the long run. It will take less overall time to pay off debts than the time taken in the snowball strategy. Another aspect of the debt snowball strategy is that you can free your income faster than the debt avalanche strategy to deal with adverse life events. Freeing up payments means that a financial crisis represents a smaller portion of your take home, meaning you're able to bear the strain without as much risk of losing something else.
The Avalanche strategy will only work if you stick to it because you may not see results as quickly as compared the Snowball strategy.
Conclusion
With the fear of recession looming over the upcoming financial year, investors should value their money & time and use these crucial resources efficiently and avoid falling into various debt traps.
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