To know how to get out of debt one must first understand why one gets into debt in first place?
Eliminating the reason of getting into debt is essential. It is essential because these days many people avails debts rather too casually.
What I mean by casually? Even when people can completely avoid the debt, they are opting to take it. This is a problem.
Debt is something which must be avoided as far as possible. Debt is not something that people must accept as a choice.
When there is no other alternative, only then people must resort to loan.
So the keyword to avail debt is “urgent requirement”. If the requirement is not urgent or unavoidable, there is no need to avail debt.
So, how to get out of debt? The best answer is, do not fall into it in first place.
These days people are increasingly falling into the debt traps as if debt is something like a tool.
One day I asked my friend who is always knee deep in debt, why you don’t limit your loan burden? His answer was very amusing.
He said, if I will not take debt then how I will “afford” such good things in life. He also said, “I am not rich, how can I buy luxury items without debt”.
When I asked him about which luxury items he avails the most, he said, international travelling, luxury furniture’s for home and latest gadgets.
I am sure many people will not find this statement wrong. In fact lot of people in India cannot afford these things. But access to easy loans makes even luxury items very accessible.
So the point is, it is good to take loan to afford luxury? And, if at all one has already taken loan, how to get out of debt?
Who needs debt?
There are three types of people who need debts. First, needy ones who are facing some urgency. Second, non-needy ones who take loan to buy comforts and luxuries of life. Third, elite people for whom taking debt is more profitable than using their own money.
The third lot of people are referred a “elite” for a reason. They are those people who earn very high returns on their invested money. The returns they earn is higher than the interest they need to pay on the debt. Hence they prefer to stay invested and take debt money to finance their needs.
But in this post we are not talking about elite people. They are in a league of their own. So lets not disturb them.
We are more concerned by first and second type of people.
How these people can get out of debt?
There are few suggestions, let have a look at them one by one, in order of my personal priority.
Suggestion #1: Make Prepayments
There is no magic wand to get out of the accumulated debt. The only way one can get out of debt is to pay off the loan.
How we pay-off loan normally? By paying our EMI’s.
This is the easiest way to get out of debt. Pay the EMI consistently on due dates and on a predefined date the loan will be paid-off.
But I am sure, if somebody is raising the query of how to get out of debt, he/she is actually asking how to get out of debt ‘faster’?
To clear ones debt faster one has to make “prepayments”.
What are prepayments? Prepayments are those sums of money which one pays over and above the monthly EMI’s.
We have a loan prepayment calculator. I will suggest you to use it to know how soon you can pay-off your loan by prepayments.
Just for example. Suppose one has a loan of Rs,20,00,000 for a 120 months period whose EMI is Rs.27,000 per month. If the person pays Rs.100,000 as prepayment in the 13th month, the loan tenure will reduce from 120 months to 111 months.
So one can continue making several prepayments every time they have extra funds in their hands. This is the most effective way to get out of debt.
Suggestion #2: Save money and accumulate funds for prepayment
What is discussed in suggestion 1 is the ONLY way to get out of debt. Balance whatever we will discuss here will be only supporting suggestion 1.
If one is carrying too much debt, they must take call that if they want to stay that way all their life.
In most cases, the answer will be a BIG NO, because majority want to get out of debt that they have mistakenly accumulated.
We know that to get out of debt, we have to make prepayments. But if one has no extra funds how to make the prepayments?
Once a person realized that he needs to get out of debt, he must go on money saving spree.
The more extra funds one will have, more money can be diverted for prepayment purpose.
Suggestion #3: Prepay your costliest debt first
Suppose one has two debts. Prepayment shall be paid to one or both?
The answer to this question is easy. Prepay first that loan which is bearing a higher interest rate.
One must not decide the prepayment priority with the loan balance. It should happen that the bigger loan gets the priority over the costlier loan.
Example: A credit card debt carries an interest burden of close to 33% per annum. A home loan carries an interest burden of around 9.5% per annum. Suppose a person carries outstanding debt of Rs.10,000 in credit card and Rs.20,00,000 in home loan. Which loan should get the prepayment first?
Irrespective of the bigger home loan amount, credit card loan should get the prepayment priority.
Idea should be to get out of credit card debt first and then take on home loan. This decision is essential because credit card bears an astronomical interest load.
Suggestion #4: Divert your investment funds for prepayment
There are people who on one side has accumulated large debts, but on other side they are also diverting their money for investing in stocks, mutual funds etc.
Though what I am saying may be debateable, but I will suggest high debt carrying people not to worry about investments.
They must divert their funds allocated for investment to make prepayments.
On an average, a common man does not earn a lot of returns on their invested money. Moreover, they eventually sell their investment holdings to buy a liability (like car, motor bikes, gadgets etc).
I do not say that everyone does like this, but majority will fall into this category.
For such people, it is a better choice to first clear the debt. They must divert whatever extra funds they have to make loan prepayments.
I personally have followed this strategy and the results are very satisfying. Today I thank myself that I preferred being “debt free”.
Suggestion #5: Switch to lower interest bearing Loan providers
Switching to low interest bearing loans will ease off ones EMI. Which means one will have some spare cash in ones pocket.
This spare cash one can use to accumulate & build the prepayment fund.
These days it does not cost a lot to switch loans from one bank to other. Even banks encourage customers to switch their outstanding loans by luring them with lower interest rates.
But before switching loans, it is essential to do bank analysis. One must not switch their loan simple because the bank is offering lower interest. Credential and reputation of banks must also be looked into.
Final words on how to get out of debt…
It is much easier to accumulate debt, than to get out of it. The analogy is very similar to weight gain.
Due to bad eating habits people gain weight. Similarly, due to bad money management, people accumulate debt.
In order to shed weight, people has to compromise on their foods and also take-up gymming. Both these tasks require lot of discipline to follow.
Similarly, it takes a lot of personal discipline to get out of debt. Prepayment of loan is the trick which works very effectively to shed-off loan.
Though a lot of people know that prepayment is the best solution to get out of debt, but very few people can actually accumulate sufficient funds for full prepayment.
In this article, we have seen practical ideas of accumulating prepayment fund. Accumulate prepayment in this way and you will be surprised to see how soon you can get out of your debt load.