Ten Strategies to Reduce your Debt
It is quick and easy and often fun to get into debt, and much more difficult to repay the resultant accumulated debt. Tens of thousands of Rands of debt can be created in a few months, but sometimes may take decades to repay. Uncontrolled debt will cripple your financial security and long-term financial planning. It is not too dramatic to say that debt can ruin your life!
If you have committed to get out of debt you will need to work on an appropriate strategy. No matter what strategy you choose, you should address the issues that caused the debt in the first place. You can use a number of strategies together or you can implement them individually.
Here are Accolade’s strategies to get out of debt and take your life back:
Prepare a Budget
The first step to a happy life is to prepare a monthly budget. This will stop you from going further into debt. It is impossible to get out of debt if you are continually adding to your debt. Your budget is the most valuable tool to help you to take control of your finances. Critically review all income and expenses. Consider alternative income sources such as generating income from a hobby. Each item on the budget should be reviewed and sensible savings considered. Your budget should have a surplus, and also provide for the monthly debt repayments. See also Accolade’s paper on preparing a budget.
Create an Emergency Fund
An emergency fund appears counterintuitive if you’re trying to reduce debt. You could be using that money to pay off your debt instead of placing it in a savings account. However, an emergency fund can actually keep you from creating more debt by providing you with a safety net you can use rather than a credit card for funding an emergency ranging from the repair of your vehicle to assisting with a family funeral. The ideal emergency fund is three to six months of living expenses, but focus on building up at least R15,000 in the short-term.
Draw up a Schedule of Assets
All your assets should be recorded together with the current market value. The useful value of each asset should be considered, as well as the viability of realising it. Where possible assets should be sold. Where a vehicle is owned under lease or hire purchase establish the equity (available cash being market value less amount outstanding on the finance agreement) would be realised in the event of sale. Consider selling the vehicle to realise the equity, and replace the vehicle with a cheaper model. This will realise cash and reduce your monthly payment as well as short term insurance. This will only be possible if your credit standing allows for a new finance agreement. The proceeds from any assets sold should be utilised as set out below.
You may consider withdrawing money from your retirement fund to pay off your debt. If you are under 55, early withdrawal penalties as well as a liability for tax may apply. When retirement comes around, your retirement savings will be short by both the money you withdrew as well as the growth you could have earned and for this reason this should be seen as a last resort. Borrowing from your retirement fund is usually only possible where a home loan facility is an option on the fund.
Cash out a Life Insurance Policy or Investment
You may have accumulated some cash in your universal life insurance or investment policy that you can put toward your debt. Be careful though, some withdrawals have penalties and tax consequences. Borrowing from your insurance policy is also an option, but will affect the death benefit your beneficiaries will receive.
Formulate a List of Liabilities
Create a list of all your liabilities. People who have excessive debt tend to not record the extent of the problem in the hope that it will miraculously go away. The list should include columns indicating the capital and repayment amount as well as interest rate. The entries in each column should be rated in order of severity, 1 for the most severe and thereafter 2, 3, 4 etcetera. Highest interest 1, largest repayment amount 1.
Repay the most Onerous Debt First
Where a lump sum or monthly amount is available to repay your debt in excess of the normal payment, you should refer to the List of Labilities and address the most onerous debt first. For example, consider settling the debt with the highest interest rate, saving interest to allow you to pay other debts or if it is possible to settle the debt with the largest payment amount this will free funds to pay the other debts quicker. This is preferable to increasing payments to all debts equally, as that way your overall payments only drop by a small amount each month. With each debt paid the saved repayment can be allocated to your remaining debts accelerating the final outcome.
Offer of Settlement of Debt
Where your debt has reached the point that the creditors have given up ever recovering their money or have resorted to legal action it may be possible to make a settlement in full and final. You will need to have access to a lump sum. Best results are achieved if a third party (parent or other relative) makes the offer on your behalf as the creditor may feel aggrieved if you try it.
Lower your Interest Rates
Higher interest rates keep you in debt longer as a large portion of your payment goes toward interest charge and not toward your actual balance. Ask your creditors to lower their interest rate. Customers with a good payment history can negotiate lower rates.
An option could be to take out a consolidation loan. If you do a consolidation loan, you want an interest rate that is lower than the rate you are currently paying. Credit cards should only be used to meet your monthly expenses and settled in full on due date. In the case of credit cards, if you settle the balance in full on the due date, no interest is raised. If you pay your credit card late or even R1 short of the balance due, interest is raised from the date of purchase to the date of settlement.
Credit Counselling and Debt Settlement Services
If you are really unable to make your monthly payments then you may consider Debt Counselling. These services will reflect on your credit report and should be a last resort before sequestration. You need to be careful about the company you choose to deal with, since many of the companies have been known to suddenly close overnight and take your money with them.
Once you have worked hard to pay off your debts, you need to work hard to stay out of debt. This means you should continue to budget, and that you need to plan for the future. You will need to create a solid financial plan that allows for investments like purchasing your first home and retirement as well as meeting medium term goals like buying a new car or overseas trips. Although paying attention to your budget is boring, the reward of doing well financially makes it worthwhile.
Accolade’s involvement would be to assist you to formulate your plan to address your debt.
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