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Debt Management for People with too many loans

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Rahul!!!

A Common man, married with a couple of children, living in tier II city.

Got married in mid-20’s, sole breadwinner in the family, getting take home of 80k every month.

Rahul was quite fascinated by how finance can help him to get what he wants and within no time. So he started accumulating loans as fast as he can.

To get married, he should have a house of his own (according to the people around him). So he booked a ready 3bhk flat by paying 10 lakhs ( a gift from the father) and took a home loan of 40 lakhs @ 9.6% interest for 240 months. So here goes the 37.5 k…

So Rahul got married, the couple settled in their new flat. Happy life with a stable job, what else you want from life? Once couple went out for dinner and Rahul’s beloved old car broke, Home minister was quite angry and ordered to purchase a new sedan asap. Order fulfilled, next month they got a brand new and shiny car worth 10 lakh. Rahul paid 2 lakhs from the savings, rest took a 60-month loan @ 11.5%. Vroooommmmmm 17.6 k…

Now the family is complete, two cute kids, one nice home, a car to get them everywhere. Rahul likes to travel too, so they take vacations every 2-3 months. Managing 3 credit cards, he usually uses them for utility and other household expenses. So overall he was doing good, being able to spend the entire take home.

Now children are growing up, got them admitted to play school. Until now all was fine but expenses have increased now. Rahul is spending 10k alone on kids’ education rest he is left with around 15 k to manage a household, pay the utility bills, maintenance, and other expenses. Most of the time, he is going over and above what he has in his hands and using a credit card.

So this fine month of march, he is being able to add another 2 lakhs dues on 3 credit card. 80000 on card 1 (36%), 50000 on card 2 (42%) & 70000 on card 3 (24%). And he is paying minimum amount only on all of them, 4k,2k and 3 k respectively.

Now Rahul is confused, I am earning a handsome pay, yet I am not being able to meet my needs. Why is it so?

It is because of taking too much debt, not planning expenses properly and next to nothing in savings.

SO let’s make a cash flow of Rahul

Income – 80000

Home loan EMI – (37546)

Car Loan EMI – (17594)

Kid’s education – (10000)

Credit card payments – (11000)

Now just subtract all of the figure in the bracket from 80k. So happy man is left with 3860/- to manage the household and to spend on other necessary stuff. Will be able to do it? The answer is No. He’ll incur more from his credit card and dues will keep increasing like anything.

This is the case of a person badly trapped in debt’s mud. Now without proper planning and strategy, it will be impossible to come out of it. The only thing which can make Rahul worry free, if he wins a big lottery. Another option is to use some debt management tool. Yes, you heard it right, there is some tool which can help Rahul to manage the debt and to make a strategy to clear it.

Let’s talk about some of them. First is snowball and second are an avalanche.

Under snowball method, smallest debt/loan will target first with increasing minimum payment towards it and as it will clear, the second smallest loan will be taken care of in similar fashion. So let’s take Rahul situation here and see if he can manage somewhat better with a snowball.

Rahul got a pay hike in April (seems like he is good at his job ;), moderate 10% hike. Also, he got some 3-4 endowment plans of LIC, his father started in his name and it’s in continuance since last 10 years. He should surrender them and use the proceedings to buy a term cover and pay off the loans. Suppose he got some 1 lakh left after taking necessary term and health insurance. Let’s see how snowball will help Rahul here…

Current situation of Rahul

Creditors in Original Interest Months to Month Paid
Chosen Order Balance Paid Pay Off Off
Card 1         80,000.00                   43,995.73 31 Oct-18
Card 2         50,000.00                   70,901.18 61 Apr-21
Card 3         70,000.00                   25,236.73 32 Nov-18
Auto Loan      6,63,256.00                1,63,667.61 48 Mar-20
Home Loan     37,62,257.00              38,60,008.76 204 Mar-33

 

Introducing snowball debt reduction tool for better management. Rahul will use 1 lakh from surrender proceedings to pay part of the debt and will increase 4000 over and above the 64k he is paying as of now.

Situation after introducing Snowball (lowest debt first)

Creditors in Original Interest Months to Month Paid
Chosen Order Balance Paid Pay Off Off
Card 2         50,000.00                     1,750.00 1 Apr-16
Card 3         70,000.00                     1,800.12 3 Jun-16
Card 1         80,000.00                   15,091.89 10 Jan-17
Auto Loan      6,63,256.00                1,12,451.49 30 Sep-18
Home Loan     37,62,257.00              18,97,464.52 97 Apr-24

 

As you can see here, Rahul can save a significant amount of interest payment, also he will be able to pay the overall debt within the much lesser time frame. Approximately, he can save a little over than 20.35 lakhs by using snowball.

Now let’s talk about Avalanche debt reduction method. Here the target with the debt which bears highest interest rate. As once clear the same, next target will the second highest rate bearing debt in the list.

So as you can see the situation of Rahul before using any debt reduction tool, he will be paying tons of interest and till eternity. Now see how an avalanche can save him.

Situation after using Avalanche (Highest interest rate debt first)

Creditors in Original Interest Months to Month Paid
Chosen Order Balance Paid Pay Off Off
Card 2         50,000.00                     1,750.00 1 Apr-16
Card 1         80,000.00                     3,756.06 4 Jul-16
Card 3         70,000.00                     8,971.32 9 Dec-16
Auto Loan      6,63,256.00                1,11,561.59 30 Sep-18
Home Loan     37,62,257.00              18,93,898.57 97 Apr-24

 

So the total savings will be 20.44 lakhs by using avalanche. Not significant but it will increase if the total debt is more than what we have used in Rahul’s case.

So if you are in the same situation as Rahul or know someone who is facing a hard time, do suggest them these techniques to manage the debt in a more target-oriented manner. Best of luck!!!

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