Snowball or avalanche? How to pay back those stubborn debts
By Nina Hendy
Millions of Australians with substantial debt hangovers have been scrambling to start the year with better financial habits and pay off their debt. But changing habits is hard.
Setting realistic targets and getting more creative about budgeting means you’re more likely to make those money-saving resolutions stick says the budgeting app WeMoney’s founder, Dan Jovevski.
Changing your habits if you’re a regular borrower can be hard, but there are methods you can use to help slash your debt.Credit: Fairfax
“Whether it’s getting rid of debt, saving for a house deposit, or simply making ends meet in our current cost of living crisis, everyone can improve their financial position,” he says.
“But it’s not about slashing your weekly budget to a level that makes you miserable, you need to be realistic to make it work.” Here are some strategies that can help you pay down your debts.
List your debts. The first step is to face facts and make a list of all the debts you owe, according to the government’s Moneysmart website. Make sure the list includes buy now pay later loans, credit cards, loan repayments, unpaid bills, fines and any other monies owed.
Make a budget. Next, make a budget so that you know exactly how much it costs you to live, what your minimum repayments are so that you can work out how much you can afford to pay towards your debts based on your current salary.
Once your debts are paid off, build a savings buffer to avoid bill stress.
Accept that financial stress is common at the start of a new year, as an overreliance on credit to get through the holiday season is common, Amy Bradney-George, credit card expert at Finder says.
“Set little goals along the way, so you’re able to track your progress over time and stay motivated – just like you might set for health and fitness,” she says. To tackle the debt, consider some of these popular debt repayment strategies:
The snowball method. This well recognised method involves listing all of your debts, from the smallest debt first, regardless of the interest rate it attracts.
Moving through the list, start by paying off the smallest debt, then move to the next biggest debt and pay that off, and so on. As debts are paid off, you cut up credit cards and close accounts.
This debt strategy continues while meeting all of your commitments and making minimum payments on other debts at the same time. The thinking here is that debt repayment gains momentum as smaller debts are paid off.
The avalanche method. This equally well-known method involves paying off the most expensive debts first. These are the debts that attract the highest rates of interest, which are usually credit cards and payday loans.
While continuing to meet your financial commitments and making minimum payments on your other debts, your spare cash is used to pay off the debt with the highest interest rate and the harshest rate terms.
Once that debt is paid off, you move to the next most expensive debt and focus repayments there, and so on. The challenge with this approach is that it can take a long time to feel as though you’re making much progress.
Debt consolidation. Combining multiple debts into one by getting a personal loan can help you manage repayments. But Moneysmart warns that it could also cost you more if the interest rate or fees are higher than before, so look before you leap.
Mozo’s database currently has 79 lenders offering zero per cent on balance transfers, which last between five and 36 months, according to Claire Frawley, Mozo’s personal finance expert.
While some cards offer generous interest-free periods, they can be accompanied by higher annual fees and a transfer fee that can be up to three per cent of the transferred balance.
“After signing up for a balance transfer credit, it’s important to make the most of the interest-free period to pay down your debt, rather than just kicking the problem down the road,” Frawley says.
“When comparing balance transfer offers, it’s important to look at the length of the zero per cent interest period and make sure it’s a realistic time frame to repay the debt,” she says.
Moneysmart warns against consolidating your debt with companies that make unrealistic promises, such as helping you get out of debt regardless of what you owe. Make sure you only deal with a licensed credit repair or debt management company.
You could also get deeper into debt if you get access to more credit through this process, which could tempt you to spend more.
Build a buffer. Once your debts are paid off, build a savings buffer to avoid bill stress, which is affecting a growing number of people during the cost of living crisis.
An emergency fund of initially $1000 should keep you out of trouble, but add to that as you can so that you’ve got at least three months of living expenses set aside.
Lastly, remember that changing your habits is hard, so give yourself some credit and allow yourself to have a cheat day ever now and again, Jovevski says.
“Order in, go out or buy those shoes. You’re much more likely to stick to your financial resolutions long term, and achieve those financial goals if you can still enjoy life.”
If you are experiencing financial hardship, contact the Small Business Debt Helpline on 1800 413 828 or sbdh.org.au or the National Debt Helpline on 1800 007 007 or ndh.org.au.
- Advice given in this article is general in nature and not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.
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