Day#16: Make a debt repayment plan.
This is Day #16 of “25 Days to Healthier Finances”, a series of blog posts where Frugal Pinoy readers and myself work on 1 task a day to make our financial lives better. Please stay tuned for the next installment of this series, which will be up tomorrow. Here’s today’s installment:
If you performed the task for Day 11 (computing your net worth), you already know how much your debt is. Now it’s time to try and eliminate it. Of course, those without any debt can skip this task.
Today’s Task: Make a debt repayment plan.
You’ll need some pen and paper, a calculator, and any paperwork referring to your debt (credit card statements, loan agreements, etc.) If you’re using a budget, it may come in handy too.
The thing about repaying debt is that there are many different ways to do it. There’s no such thing as “The Solution”, there’s only what works for you. Here are some common methods you should think about:
The Highest-Interest Method
- Make a list of all your debt including credit cards, mortgages, and other kinds of loans. Remember to include personal loans such as money lent to you by relatives or friends.
- For every item on that list, write down the following: remaining repayment balance, current interest rate, and the minimum monthly payment.
- Spot the debt with the highest interest rate, then rank the rest of your debt accordingly. (The one with the second-highest rate is #2, the third-highest rate is #3, and so on.)
- Any extra money you save or earn each month should be channeled to repaying the debt with the highest interest first until it is fully paid. Keep paying your minimum payments to your other debts, but the extra cash should go to the one with the highest interest debt until you’ve eliminated it from your list.
- Repeat as needed until you’ve repaid all your debts.
The benefit of this approach is that it tends to be faster. If you have the discipline to do this, you won’t accumulate more debt via large interest rates.
The Debt Snowball Method
This method, popularized by Dave Ramsey, is a more psychological approach to debt repayment. Instead of paying off the loan with the highest interest rate first, you start with the one with the smallest balance. By crossing out one debt from your list, you’ll get an emotional boost and hopefully become more inspired to get out of debt. Here are the steps to do it:
- List all your debt in ascending order, with the smallest balance first.
- Each month, commit to pay the minimum payment on all your debts while channeling extra saved/earned money to the debt with the lowest balance.
- Once you’ve paid off the first debt, the money that used to go to that debt (at least the minimum payment) should now go to repaying the debt with the second smallest balance.
- Repeat until you’ve repaid all your debts.
Usually, if your debt with the smallest balance isn’t the one with the highest interest, it may take you longer (and a bit more money) to pay it back. The math just doesn’t side with the debt snowball method. But if you know yourself well enough to know that you’ll need the inspirational boost to cross off one debt from your list, then this is the approach to take.
Variations of the Above Methods
You can do a combination of both of the above methods, of course. One way to do it is to “snowball” your first complete repayment – pay the one with the lowest balance first. Once you’ve repaid that, maybe you can pay the rest of your debts according to their interest rates. Whatever happens, you must make the minimum payment for each debt each month. Otherwise, you’ll usually incur more interest and additional fees.
If you’ve gotten out of debt (or stayed out of it to begin with, like I have), please share your story with other Frugal Pinoy readers by submitting a comment.
Bloodlines as Credit Lines
(Thanks to Soli for the title and insight.)
Here in the Philippines, it’s ordinary to seek out the help of close friends and family whenever we’re in financial need. There are even cases where mere acquaintances ask each other for monetary assistance. We’re generally matulungin (helpful) as a culture, and that’s not necessarily a bad thing. Let’s take a deeper look into the idea of using blood lines as credit lines.
Why it works to ask friends and family for financial aid:
It’s part of our culture. From the concept of bayanihan to proverbs about being a “good Samaritan”, at an early age we’re taught to be helpful.
It’s easy. All it takes is a phone call, a visit, or even a text message. “Pare, pautang naman, o!” These people are close to us, and most of them are willing to do anything to help us keep out of trouble. It beats filling up long forms and attending interviews when applying for a loan.
In some cases, it makes sense. If you’re a fresh graduate, starting a new career, and need to help support the rest of your family, it’s hard to find the extra funds to save up for retirement or an emergency fund. Also, for people who find themselves in financial emergencies and didn’t have the foresight to plan for them, they are left with no choice except to ask for help. After all, it’s much better than using a credit card with steep fees and interest rates.
Now let’s look at the other side of the story.
Why it is also dangerous to ask family and friends for financial assistance:
Apart from the money you borrow, there will also be utang na loob. And that is a much trickier transaction to measure. One never knows when utang na loob is ever repaid in full. If someone lends you money and later requests for non-monetary help, you feel obligated to give in – no matter how uncomfortable you may be with some of these requests. Hey, it might not even be your debt, it could be your parents’ – but it doesn’t stop you from feeling utang na loob.
Unsurprisingly, the idea of utang na loob, intended as a display of genuine gratitude, has become one of the foundations of corruption in this country.
Sometimes too much help can turn into hindrance. Someone I know, let’s call her Ms. A, was surrounded by friends and family who gave her financial assistance whenever she needed it. Her loved ones thought that they were helping her. However, the core of the problem wasn’t really a stroke of financial bad luck – Ms. A just had such poor money sense. She spent too much money on unnecessary things. Because everyone was always there to “help” her, she never got around to addressing this problem. The result? Mountains and mountains of unpaid debt – with more on the way. She’s become completely dependent on others and doesn’t even feel the need to look for a source of income via a job or business.
It puts a strain on the relationship. When money comes into the picture, a new aspect of your relationship surfaces. I’ve known of families that have had near or completely irreparable relationship strains because of money. Sisters don’t speak to each other for decades because of unpaid debt. A father disowns a son who doesn’t want to pull his own financial weight. People who were formerly friends start avoiding each other. For this reason alone, I don’t think it’s worth it to rely on friends and family for financial aid.
What is the solution?
Consider what you know about the other person. When borrowing from a relative or friend, or when lending money, think about the other person’s financial sense and what kind of strain this might put on your relationship. Is this person money smart but just ran into some unexpected bad luck? If you’re the one borrowing money, ask yourself if the lender trusts you enough to repay the loan.
Think about other options. Borrowing and lending may not be the only solution to financial problems. Are there items that you can sell? Is there a regular expense that the borrower spends needless amount of money on? Long lasting help doesn’t come in the form of cash, rather it comes in a finding a system that works. That saying about teaching a man how to fish – that one applies here.
Every situation is different, but these are just some things to keep in mind whenever you come across a financial problem where you may have to use your own network of friends or family as financial backup.
Have you ever borrowed money from a relative or friend? Have you ever lent anyone money? Feel free to share your experiences in the comments.
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