The first thing to remember when wrangling with liabilities is that there isn’t a guaranteed best way to get out of debt. How fast you can get out of debt depends on the size of your liabilities, their interest rates, your income, and your debt repayment strategy.
One certain thing is that you’ll have to spend intentionally and cut back on luxuries. Strategy is key when trying to get rid of debt, and we’ll share some debt repayment strategies.
The debt snowball helps you get rid of debt by tackling them individually, starting with the smallest and gradually moving to the largest. First, you’ll have to allocate a percentage of your monthly income to repaying debts; you can call it your debt repayment fund.
Here’s how it works:
List your debts from the smallest to the largest, irrespective of the interest rate.
Pay the minimum required amount on all debts monthly.
Dedicate the rest of your repayment fund to paying off the smallest debt.
Keep at this until you’ve paid off the smallest debt.
Move on to the next smallest and repeat the process.
The debt snowball is a great way to get out of debt fast as you’ll scratch more debts off your list relatively quickly while creating momentum with every debt you repay.
However, keep in mind that this method works best when the interest rate on debts are minimal. If the interest rate is an important pain point, then the next debt repayment strategy is more suited.
Tami’s monthly income is ₦500,000 and she has four major liabilities:
Car loan: ₦3 million for 2 years with required monthly payment: ₦125,000
Inventory loan: ₦800,000 for with required monthly payment: ₦53,500
iPhone 12 Pro Max loan: ₦420,000 for 1 year with required monthly payment: ₦35,000
Mortgage: ₦20 million for 15 years with required monthly payment: ₦83,500
Using the debt snowball, she would first sort her debt from the smallest to the largest regardless of interest, i.e.
iPhone 12 Pro Max: ₦420,000
Car loan: ₦3 million
Mortgage: ₦20 million
The monthly required payment is the minimum amount you must pay every month towards clearing your debt. Summed up, the total required payments per month is ₦297,000; a good example of how debt can creep up and swallow your finances.
If Tami allocates ₦350,000 every month to debt repayment, she’d have ₦53,000 left over after paying the total required minimum.
She can then commit the extra ₦53,000 into repaying the smallest debt i.e., the iPhone debt. In total, she’d put ₦88,000 every month into getting out of her iPhone debt i.e., ₦35,000 + ₦53,000 left from repayment funds.
At this rate, she’d pay off her iPhone debt in five months after which she would move on to the next largest debt: the inventory debt.
Now, the minimum required monthly payment drops to ₦262,000, freeing up more cash to pay off the next debt (the inventory loan). When repaying the inventory loan, Tami would have ₦88,000 extra, bringing the total amount put towards clearing the loan to ₦141,500.
Remember that she paid the minimum monthly deposit on the inventory while paying off the iPhone loan, so when she gets to the inventory loan, she would have already paid ₦267,000, leaving a balance of ₦532,500.
At a rate of ₦141,500 per month, she’d get rid of her inventory debt in four months.
With each loan fully repaid, Tami frees up more funds to tackle the next loan, not to mention that the minimum required monthly payment helps her clear her loans even when she’s not actively focused on them.
By the time she gets to the largest loan, she will have already gotten rid of a significant portion of the debt.
The Debt Snowball can be tough in the first few months, but it gets easier over time as you build momentum. With this method, all debts in our example will be paid off in 6 years.
The car, iPhone, and inventory debt takes only 23 months to pay off while the mortgage takes up a hefty 57 months. However, after paying off the car, inventory, and iPhone loans, you can reduce the portion of your salary allocated to paying off debt. And considering the largest debt is the mortgage with a repayment period of 20 years, you don’t have to be in a rush to pay that off.
Also, note that the repayment fund allocation we used may not always be applicable. You may not be able to commit ₦350,000 out of ₦500,000 a month to pay off debts. In these cases, you can reduce the amount you commit each month. You’ll spend more time getting out of debt, but that’s okay.
Keep in mind that this method works best with negligible or flat interest rates. When straight-line interest rates are a major pain point, the debt avalanche strategy is more suitable.
The avalanche strategy centers on starting with debts with the highest interest rates as steep rates can compound, increasing the overall amount you’ll have to repay.
Here’s how it works:
List your debts in order of descending interest rates.
Pay the minimum required amounts on all debts monthly.
Focus the rest of your repayment funds on paying off the debt with the highest interest rate.
Move on to the debt with the next highest interest rate and repeat the process.
The debt avalanche may not be the fastest way to get out of debt, but it seems the cheapest. However, you’ll need a healthy dose of motivation as the debt you start with may be the largest and hardest to repay.
Now that you’re familiar with the two most popular debt repayment strategies, it’s time to apply them to your overall strategy.
Seun is struggling with the same debts as Tami, but this time he has to pay interest on his loans:
Also, these rates are straight-line interest rates with one-month payment periods i.e., the annual interest is calculated as a percentage markup of the principal and divided by 12 months to determine how much interest is owed per month.
Sorting the loans by interest rate from the highest to the lowest gives:
Minimum Required Payment
iPhone 12 Pro Max
Seun starts with inventory because it has the highest interest rate. He pays the minimum required payment of ₦296,000 for all debts, then focuses on the inventory loan, following the same commitment of ₦350,000.
After paying the minimum required payments for all loans, Seun commits the extra ₦54,000 to pay the inventory loan, making a total of ₦105,500 committed to repaying the inventory loan per month. Naturally, He would repay the loan in 8 months, however, the interest rate is now a factor.
Remember that all the loans accrue interest every month even while being paid. Since the inventory loan has an annual interest of 17%, the loan would accrue 11.3% interest (i.e., ₦90,400) in the eight months it takes to repay. Seun would then repay a total of ₦890,400 and spend nine months repaying the first debt.
In the nine months it takes Seun to pay off the first loan, other loans would have each accrued nine months’ worth of interest. Therefore, you must start with the loan with the highest interest rate.
When he gets to the second debt, the size of what he must pay would have increased to ₦464,100. However, he would have already paid ₦315,000 thanks to minimum monthly payments.
Committing a total of ₦141,500 per month to repay the iPhone loan, Seun would be able to clear the second loan in one month.
By the time Seun gets to the third debt, the total amount owed for the car loan would have increased to ₦3,324,900. However, he would have already paid ₦1,250,000 via monthly minimum payment, leaving ₦2,047,900.
At a rate of ₦266,500 every month, because he has freed up more cash thanks to paying off other loans, Seun will be able to get rid of his debt in eight months. The same applies to the last loan.
In the end, using the avalanche method, Seun would be able to get out of debt in 7 years. While not the fastest way to get out of debt, it is the cheapest for straight-line interest rates.
Write down all the debts you owe, including their interest rates and repayment period, so you have an overview of what you owe. A list helps you keep track of the most dangerous debts (usually the ones with high interest rates) and informs your repayment strategy.
Even the most thought-out plans can be derailed by unforeseen costs and emergencies; that’s why you need emergency funds. They act as buffers that absorb sudden costs without diverting your repayment funds.
This is dicey and should not be taken as a definite rule. If you want to get rid of debt as quickly as possible, then the cash you would have saved every month can be diverted into paying off your debt.
Remember that you should have some emergency cash, so diverting your savings won’t leave you completely without a safety net.
Note that when we say, “divert your savings”, we mean the money flowing in from your income, not what you already have saved.
There’s usually a minimum required payment you’ll have to make on each debt every month, however, it’s best to desist from going over the minimum payment for a debt you’re not actively focused on.
In essence, pay the minimum on all debts, but focus the remaining funds towards paying off one debt. When you finish paying it off, move to another one and focus on that. This will help you pay off your debts much faster and build momentum as you see your debts clear one after another.
Supplementing your income with side hustles and investments is usually a good idea. However, keep in mind that when your net worth is below a certain threshold, lifestyle changes are more effective than investing.
For example, say your monthly income is ₦200,000, and after expenses, you have ₦70,000 left. If you put that money into a mutual fund with a 13% APY (which is generous for Nigeria), you’d make ₦9,100 in a year.
However, if you can cut down your transport cost from ₦1,000 to ₦700 per day, you’d save ₦300 daily. In a month, you’d save ₦6000 and in a year, ₦72,000.
The first step to getting out of debt is to stop getting into more debt. Write down all your expenses and chop off everything unnecessary.
Make a list of the debts you’ve incurred and their interest rates.
Use the snowball method for flat or negligible interest rates and the avalanche method for straight-line rates i.e. rates where you have to pay an annual interest every period.
Save a little money for emergencies (ideally 3 – 4 months’ worth) so unplanned expenses don’t derail your plan.
Focus on interest-bearing debts first.
Stick to the plan, tackle one debt at a time.
Be careful when supplementing your income with a side hustle. Most times, they take money before they give.
In the end, the fastest way out of debt depends on how willing you are to plan and execute your debt repayment strategy. Goodluck.