We read many reports on the rising household debts of Singaporeans and how it is one of the highest in the region. It does not matter whether household debt is a good indication of our debt problem, there is one thing we know for sure.
The average household debt of Singaporean is at S$55,112 per capita. The household debt is defined as the amount of money that all adults in the household owe financial institutions. It includes consumer debt and mortgage loans.
This means that by a certain age, Singaporeans will find themselves knees deep in debt, be it from their mortgage loan, car loan or their personal loans. Despite numerous coverages on the danger of which, what most articles lack is a proper method to get rid of these debts.
In what order should you be clearing your debts? Should you clear the smallest debt or the biggest one?
Most of us are faced with the same scenario once a month, but little care to find out.
There is basically two schools of thoughts, the debt-snowball method and debt-avalanche method. Each with their Pros and Cons.
We have attached a debt reduction calculator for our readers before we go on and explain the details of the methods. Do copy and use it for your own.
Debt Snowball Method
Imagine a tiny snowball rolling down a hill. It starts small, but as it rolls down the hill, it adds another layer of snow, growing larger and larger and gaining momentum.
This is what this theory of paying off your debt is about.
How Does ‘Debt Snowball’ Works?
1. List your debts in order, from the smallest to largest by amount owed (do not include mortgage loans in this list, we will handle mortgage last). Ignore the interest rates when making your list. Just focus on the amount of debt.
Assuming you have these debts:
- $100 Telephone Bills (minimum payment $25)
- $2,000 Credit Card Bills (minimum payment $50)
- $10,000 Student Loans (minimum payment $100)
- $15,000 Car Loans (minimum payment $75)
2. From here, using the amount of money of your salary you set aside to pay your loans, pay the minimum payment for all the debts and throw whatever that is left towards the smallest debt, which in this case, phone bills.
3. Now, having crossed phone bills off the list, you free out an addition $25 to channel to the next smallest debt for the next month. When you start eliminating easier debts, you see immediate results and stay motivated to dump your debt. With each debt being crossed out of your list, your cash flow increases and before you know it, you are able to cancel off the largest debt.
Pros of Debt Snowball Method
This method rides on the psychological aspect of human minds. It is satisfying crossing a debt off your list and you get a boost from which.
Snowballing also makes life more convenient. With every debt paid off, one will now have one less payment to remember to make, one less electronic payment to schedule.
Cons of Debt Snowball Method
Interest is powerful, and it may work against you.
This method requires a high level of discipline too. Given that you free up money quickly, the fate of extra cash lies in your discipline.
Will you use it to clear that next bulk of debt or on that shirt you have been eyeing for the longest time?
Debt Avalanche Method
How Does Debt Avalanche Works?
- Also known at the stacking method, list all your debts in order of interest rate, from highest to lowest. This time ignoring the amount of the debt too.
- Regardless of the amount of debt for each, one will repay as much money as he can for the debt with the highest interest rate. Once each debt is paid, one will move on to the next highest interest rate debt. One will continue doing this until all his debts are cleared.
Pros of Debt Avalanche Method
This method makes the most financial sense. One will be able to reduce the amount he pays due to interest rate when using this method. Minimising such payment as much as possible is the cornerstone of being financially healthy.
Cons of Debt Avalanche Method
By using this method, it can be rather discouraging since it will take a while to pay off debts. One will not be able to obtain the quick satisfaction of paying something off fast. This method requires an even higher amount of discipline than the previous method.
If you have more questions, we have an open community for you to get your questions answered and to hear from different perspectives. Check out our blog for more unbiased opinions on your personal finance journey.
Share with us if you have any experience with these or even a better alternative by commenting below!