How can you pay off your loans faster?
Often, a series of unfortunate events – a sudden job loss, serious illness or expensive repairs – can set you back financially. It is during such times that many of us turn to the banks and financial institutions for help.
According to the UAE Central Bank, the total value of loans to UAE residents, as of April 2016, stood at AED339 billion. Whether it is out of sheer necessity, for investment purposes, or to simply improve your lifestyle, there is a dire need to prevent yourself from falling into an unhealthy cycle of debt.
Having a reckless attitude towards debt can eventually overwhelm you with more debt than you can manage to pay off comfortably. Hefty loan repayments, credit card bills and accumulating interest not only swallow up your monthly income, but also leave you with little or nothing to save.
Personal debt comes in various forms, be it credit card debt, mortgages, car loans or personal loans.
Debt stacking is a loan repayment method that ranks your loans based on the interest rates, from highest to lowest, and helps you get rid of the most expensive loan you owe sooner.
Using this method, you keep paying the standard installments on your loans and a minimum amount due every month. After this, you use either the extra money left over or your monthly savings towards paying off the loan with the highest interest rate.
Once you have settled the loan with the highest rank, you then use your extra money to settle the next loan on your list and so on, until you’ve paid off all your loans. Debt stacking helps you save by reducing the total interest you would pay.
Let’s assume you have a credit card with bank ABC and an outstanding balance of AED5,000 (at an Annual Percentage Rate of 25 per cent) and another credit card from XYZ bank with AED10,000 balance (at an APR of 30 per cent), a car loan balance of AED40,000 (at six per cent per annum) and a personal loan balance of AED50,000 (at four per cent p.a.).
Under the debt stacking method, you would rank your debt based on the interest in a descending order in the following manner and aim to pay off the first one on the list, subsequently moving on to the next.
- XYZ bank’s credit card at 30 per cent p.a.
- ABC bank’s credit card at 25 per cent p.a.
- Car loan at six per cent p.a.
- Personal loan at four per cent p.a.
Watch out for…
While this method cuts down interest amounts, it can turn out to be a long and slow process. Especially, in the case where the loan with the highest interest rate is the one with the highest outstanding amount, it may take a while to experience the feeling of accomplishment of striking off this big debt.
Under this method, your aim is to settle the lowest outstanding amount, irrespective of interest rates. Debt snowball lets you rank your loans in an ascending order, based on the total amount outstanding. While you continue to make minimum payments towards all your loans, any extra money should be used to pay off the smallest loan and so on. This will enable you to wipe it off debt from your books faster.
Taking the same example as above, this is how your loans will be ranked:
- ABC bank’s credit card – AED5000
- XYZ bank’s credit card- AED10,000
- Car loan – AED40,000
- Personal loan- AED50,000
Watch out for…
While you may feel a sense of achievement as you strike off loans faster, this method may not be as cost-effective as debt stacking. This is because the smallest loan that you would be paying off first could also be the one with the lowest interest rate, forcing you to keep more expensive loans on your books for longer.
If you wish to find out some of the repayment strategies from Souqalmal.com, please click here.