- Luke Ferguson, Fiscal Private Client Services
Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t, pays it.” This statement highlights the power of interest, which can work for or against you. For those burdened with debt, compounding interest often means paying far more over time than the original amount borrowed.
Debt can be a major source of stress, and many individuals struggle to find a way out. A 2023 study found that 87% of South Africans experienced financial stress, with almost 50% struggling to meet basic monthly needs like food and rent. This financial strain frequently leads to increasing debt levels as people turn to credit to make ends meet. If you feel overwhelmed by debt, it is important to adopt a structured approach rather than making random shotgun payments across multiple debts. Having a clear strategy can provide a sense of control and improve financial stability over time.
Step 1: Assess Your Financial Situation
The first step in tackling debt is understanding your financial situation. Start by reviewing your bank statements and tracking all expenses to create a comprehensive budget. This will help you determine where your money is going and identify areas where you can cut back. By freeing up extra cash, you can allocate more funds toward paying off debt, ultimately reducing financial stress and improving your financial outlook.
Step 2: List Your Debts
Once you have a clear picture of your finances, make a detailed list of all your debts. Include the following key details for each:
- The total amount owed
- The interest rate
- The minimum monthly payment
Understanding these factors will help you prioritise which debts to tackle first. It is important to note that not all debts are created equal; credit card debt, for example, usually carries much higher interest rates than personal or home loans. Knowing these differences will help determine the most effective repayment strategy.
Step 3: Choose a Repayment Strategy
There are several strategies for paying off debt, but two of the most widely used methods are the ‘avalanche method’ and the ‘snowball method’.
Avalanche Method (Cost-Effective Approach)
This approach focuses on paying off the debt with the highest interest rate first while making minimum payments on the rest. Since high-interest debt, such as credit card balances, accumulates quickly, eliminating it first can save money in the long run.
Pros: Saves the most money on interest and can lead to faster debt repayment.
Cons: It may take longer to see progress, which can be discouraging.
Snowball Method (Motivational Approach)
This method focuses on paying off the smallest debt first, regardless of interest rate, while making minimum payments on the others. Once the smallest debt is cleared, the amount previously allocated to it is rolled into the next smallest debt, creating momentum.
Pros: Provides quick wins and a psychological boost as debts are eliminated.
Cons: May take longer to become debt-free and can result in paying more interest overall.
Step 4: Reduce Future Debt Temptation
Paying off debt is an accomplishment, but staying debt-free requires discipline. Consider closing paid-off accounts to avoid the temptation of using credit again. Additionally, consulting a financial planner can help develop a sustainable long-term financial plan.
Final Thoughts
Becoming debt-free takes dedication, consistency, and the right strategy. Whether you choose the avalanche or snowball method, the key is to commit to the process and avoid taking on unnecessary new debt. By taking control of your finances today, you pave the way for a more secure and stress-free future.