Are you feeling the weight of a large debt? This could be a home mortgage, a person loan, credit card debit or a combination of several debts.
If you are consistently struggling to make repayments, this can have knock-on effects for all other aspects of your life. These 10 tips for debt elimination strategies will help you to free you from your debt as soon as possible.
- Rapid Pay Off or “Debt Avalanche”
If you have two or more debts to pay off, one good technique can be to select one and pay this off as quickly as possible, before addressing your other debts. This is called a rapid pay off or “debt avalanche”. The advantage of this approach is that you will eliminate this first debt as soon as possible, meaning that you will no longer be paying interest or fees on that debt. Once the first debt is paid off, you can turn your attention to other debts and apply the same technique.
Carefully budget your income and expenditure and put all available money towards your debt avalanche. If you receive any extra cash, put this toward the debt also.
In order to choose which debt you will pay first through rapid pay off, here is a simple 6 step process to use the ‘debt avalanche’ technique:
1) List out all your debts: who is owed and for what.
2) Include how much is owed for each debt and the total balance.
3) Record the minimum monthly repayments on each.
4) Take the amount owed on each debt and divide this by the minimum monthly repayment.
5) List the interest rate on each debt.
6) Decide which debt to pay off first. The debt which has the lowest number from this calculation will be the one which is most greatly impacting your cash flow in the short term, and so the one which you want to pay off first through your debt avalanche. This will generally by the debt with the highest interest rates, but not always.
- Debt Consolidation
Consolidating your debts together can be a great way to reduce interest and fees, and will save you money in the long run while you pay off your debts. In practice, debt consolidation means taking out a bigger loan and paying off your smaller loans. Usually, it is best practice to increase the amount of the one of your debts which has the lowest interest rate and lowest monthly repayments, which is most often your home loan.
Once you have increased your home loan and used this amount to pay off smaller, higher interest debts with higher monthly repayments your debt will all be under one loan with a single, lower monthly repayment. You will also be accruing less interest in total each month, meaning more of your repayments are going toward paying off the principle of the loan rather than simply paying interest.
To increase your home loan you can either refinance your mortgage with your current lender, or seek refinancing with another institution. Other things to keep in mind when refinancing are to try to find an option where you make fortnightly rather than monthly repayments, and that the bank or mortgage lender makes calculations on your loan daily rather than monthly – both these things can represent significant savings. And, of course, make sure that you are meeting your repayments and do not let small debts accumulate again!
Another strategy you could use to consolidate and ultimately eliminate your debt is through a line-of-credit loan, though this is a somewhat aggressive and even risky strategy. Under a line-of-credit loan, you use your house as security against a large loan from a bank or financial institution, who will offer you a more favorable interest rate compared to a credit card or personal loan, because they have your house as a guarantee. This way, the interest rate will be approximately the same as a home loan, so this can be a good alternative to refinancing your mortgage should that not be a viable option.
In a line-of-credit loan, also known as a “revolving line of credit”, the lender will usually lend up to 80% of the value of your house and as you be able to access extra money (“credit”) as you need it, up to the maximum amount of credit allowed. This means even as you pay down your debt, you can draw extra credit if you need it. The bank will calculate interest on a daily basis based on your loan balance. Therefore, the lower you keep the balance overall even if you need to occasionally borrow more to meet expenses, the less interest you will pay overall.
- Draw Passive Income from Equity
If you have a large asset like a house, whatever percentage of this you own outright is equity which you have. You can therefore use this equity to buy further assets which generate a positive cash flow overall, after the costs of loans have been considered. These are known as “higher income yielding assets” and generate extra income which you can then use to pay down your debts.
This can be any kind of investment, but you need to do careful research to make sure that this investment will definitely deliver a positive cash flow overall. Additionally, you need to consider the time and effort necessary to manage this investment and whether that is justified by the income it generates.
- When All Else Fails
If your financial situation is too severe, or has progressed too far beyond these debt consolidation strategies, the next steps may be more around making arrangements with your creditors to manage your debt rather than simply looking to reduce it over time. These next strategies are the “last resort” techniques which should be applied when all else fails.
- Informal Agreement
Your creditors may also agree to enter an informal agreement or informal arrangement to give you a little more time. This agreement is non-legally binding but your creditors allow you extra time to pay your debt before they proceed with legal action. Creditors will usually agree to this in specific circumstances, including genuine financial hardship, and generally all of your creditors will need to agree or otherwise it may jeopardize the overall agreement.
- Debt Agreement
You may be able to come to an agreement with your creditors which will make your debt more manageable, for example through changing or delaying the amounts of regular repayments. These agreements are legally binding to all parties and may involve you putting up some kind of guarantee, for example an arrangement where the creditor will be allowed to seize your house if repayments are not made.
These kinds of agreements have very specific criteria, so careful investigation is needed. For example, you cannot set up a debt agreement if you have previously been bankrupt. It is also worth noting that a debt agreement may affect your credit rating, and failure to follow through on the agreement (as in make the agreed repayments) can officially make you bankrupt.
- Part IX and X Arrangements
Part IX and Part X arrangements are an alternative to bankruptcy, although these are only an option if all creditors agree (or at least a majority of creditors holding 75% of the dollar value of your debts). The advantage of Part IX and X arrangements is that you may still be able to keep some of your assets and even continue to operate your business.
Under these arrangements, a proposal is drawn up and accepted by a majority of creditors, with an administrator appointed to manage the arrangement. Under Part X this must be a registered trustee. In Part IX, the administration may be a friend or associate, but there is a limit on your assets and debts.
Bankruptcy is certainly something which should only be considered as a last resort, and has many long-term impacts. Once all alternatives have been investigated and exhausted, however, bankruptcy may be your only remaining option. Bankruptcy can occur either voluntary (that is if you declare yourself bankrupt), or through a creditor or creditors’ action.
Once you have been declared bankrupt, any remaining unsecured creditors are no longer able to take action against you in order to satisfy their debt, though they may lodge claims in the bankruptcy. However, you will then be considered bankrupt for at least 3 years, and in some cases 5 or 8 years. During this time you will be limited in terms of what assets you can own, and your credit rating will be severely damaged. You are also still liable to pay Government debts, legal fines, on-going expenses such as utilities bills and maintenance payments.
- How To Prevent Crippling Debt
Rather than resorting to bankruptcy or Part IX or X measures, it is much better to avoid uncontrollable of crippling financial debt in the first place. Seeking advice from a financial advisor on debt management and debt elimination as early as possible, even at the time of taking out the loan, will help to do this. A financial advisor will also be able to help you decide which of the strategies mentioned here are best for your personal situation. Above all, the best thing you can do is address your debt opening and directly, rather than ignoring it or avoiding the issue.