Just as there are many ways to get into debt, there are many ways to get out of it. Choosing the right strategy and coming up with a workable plan can be the difference between years of struggle and tens of thousands of dollars. In this article, we explore different debt strategies and how having the right plan can fast-track your financial goals.
An average couple with above-average debt
Before we start talking about debt strategies, we’d love you to meet Megan and Creagh. They’re in their thirties, married, living in Sydney and both have steady jobs. By all accounts, they’re an average couple, except for the fact that they ended up with an above-average amount of credit card debt. The average Australian credit card balance is around $3,600, while Megan and Creagh’s cards added up to a heart-pounding $91,000.
“It wasn’t big lavish expenses that got us into trouble—it was day to day stuff,” Creagh explains. The couple admits that they regularly overspent on little things—such as going out to eat instead of cooking at home—that added up to a lot over time. And when their credit card balance got too high to handle, they took out new cards with zero-interest balance transfers, only to end up with multiple cards with multiple balances attracting high interest rates. “What we were doing wasn’t working,” says Megan.
Causes of debt stress
Megan and Creagh are not alone in juggling multiple credit cards. Across all income levels, a recent Finder survey reports that around one-in-five Australians (17 to 20%) have three or more credit cards at the same time. This helps to explain why credit card debt is a leading cause of financial stress, but it’s not the only one. Mortgage stress is also on the rise and household debt has doubled in relation to annual household income over the last 20 years, making Australians some of the most indebted people in the world.
The truth, however, is that any type and level of debt can cause stress. Personal debts, such as car loans, buy-now-pay-later debts, such as Afterpay and interest-free consumer loans, even informal loans from family and friends, can all be debts to lose sleep over. The key to reducing stress and debt levels is to come up with a plan that works for you.
The ‘Avalanche Method’
Logically, the quickest way to reduce your debt is to pay down the most expensive debts first. These are the loans that attract the highest rates of interest. Credit cards are likely targets, as are store cards, revolving lines of credit and quick cash loans.
We call it the Avalanche Method and it goes like this:
While meeting your commitments and making minimum payments on your other debts, focus all of your spare cash on paying down the debt that has the highest rate of interest. Once that debt is paid off, focus on the next most expensive debt and so on.
This strategy is great for debt reduction because it minimises the amount of interest you pay over time. But the challenge of the Avalanche Method approach is that it can take a long time to feel like you’re making any progress. If your balance is sizeable, most of your payments will be taken up by interest charges.
The ‘Snowball Method’
Attacking your most expensive debt first is logical, but is it the most effective approach? Perhaps not always. It’s worth acknowledging that money has an emotional component and that motivation is an important factor in sticking to whatever plan you come up with.
For people with a lot of debt, for instance, the Avalanche Method could feel like the equivalent of going to the gym for months on end and never seeing any real progress. It would be easy to lose faith and slide back into old habits.
Money is the same. That’s why sometimes it pays to focus on smaller debts first, even when they aren’t the most expensive ones. It’s about getting ahead and experiencing the joy of progress.
We call it the Snowball Method and it goes like this:
While meeting your commitments and making minimum payments on your other debts, focus all of your spare cash on paying off your smallest debt first, regardless of the rate of interest it attracts. When that debt is paid off, move to the next biggest debt, and so on.
The Snowball Method gets its name because it gains momentum as smaller debts are paid off and the repayments are applied to larger debts. Along the way, you get to cut up credit cards, close accounts and celebrate multiple milestones.
The ‘Feel Good Method’
Another often overlooked factor in debt reduction is how your debts make you feel. Money can be highly emotional, especially when relationships are involved. In fact, financial stress is one of the leading causes of relationship tension and divorce. Sometimes, therefore, the best strategy is to focus on paying off the debts that make you feel the worst. It might be $1,000 you owe your grandma or a credit contract on a phone you lost six months ago.
We call it the Feel Good Method and it goes like this:
While meeting your commitments and making minimum payments on your other debts, focus all of your spare cash on paying off the debt that will make you feel the best when it’s gone. When that debt is paid off, move to the next debt that will make you feel the best, and so on.
This can be an excellent way to rebuild stressed relationships and feel better about yourself. After all, whatever your financial goals are, the end goal is not a physical destination or object, it’s a feeling—a feeling of freedom, security, calm, relief, and being free from money worries.
Back to Megan and Creagh
One of the biggest challenges of coming up with a workable debt strategy is being able to see your financial situation clearly. This isn’t always possible when you’re dealing with financial stress or even just juggling the week-to-week demands of living. In those circumstances, there are benefits in talking to a friend or independent person who can look at the situation for you.
Megan and Creagh decided to approach MyBudget. One of our Money Coaches went through their finances in detail and designed a customised plan that mapped out all of their income and expenses over the next 12-months. Both of them were surprised by how far their money could actually go.
The plan ticked all of their boxes by taking into account the strategies mentioned above: those debts that were costing the most, those that could be paid off quickly and those that would feel great to get rid of. Creagh says, “We told them [MyBudget] what we wanted to try to keep a hold of and they built the plan around that.”
Megan and Creagh now have structure to work within. They still eat out regularly, but their spending now has limits and their income is organised into streams that take into account all of their future expenses and savings. By sticking to the plan they know exactly how and when they’ll achieve their financial goals.
The result is that Megan and Creagh have been able to pay off five credit cards in 10 months (about $60,000 of debt) and they now have their sights set on a house deposit. “I’m so proud of us and what we’ve done together, that’s a big deal for me. It’s a feeling of elation. I can breathe out,” says Megan with a smile.
To enquire about a customised debt strategy that works for YOU, contact MyBudget today to request a free consultation. The budget plan we design is yours to keep.
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