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Payment Strategies

Debt Counsellors provide an important public service in the form of developing payment strategies that do not require your personal finances to be restructured. A debt counsellor offers specialised financial advice regarding budgeting, debt repayment and various other debt reduction strategies.

One of the key roles of an effective counsellor is to help consumers negotiate more flexible debt payment terms. For example, by extending the loan term, postponing the repayment, or lowering the interest rate on the debt.

Payment strategies are most effective when applied to credit card debt. Ideal for people who have money left over after repaying debts, payment strategies can help save interest, and ultimately become debt free faster.

For those who have no money left over after paying their debts, payment strategies are not a good option. Instead, consider a personal insolvency agreement or filing for bankruptcy.

What is the effect of only making minimum payments?

If you only make minimum payments, you will eventually become debt free, but it will take much longer and cost much more in interest fees. Consider these numbers:

  • Credit Card A – balance $1000 – Rate 27% – Repayment $30
  • Credit Card B – balance $2000 – Rate 10% – Repayment $40
  • Credit Card C – balance $2500 – Rate 15% – Repayment $50
    Results
  • Time until debt free: 79 Months
  • Total paid: $8415.00

Option 1: High Interest Payment Strategy

The fastest way to repay debt is to take extra money left over at the end of the month and apply it to your highest interest debts. Follow this formula:

  1. Put all debts into a list, from highest to lowest interest rates
  2. List the minimum payment allowed for every debt
  3. Calculate how much money is left after making the minimum payments
  4. Pay the minimum repayment on debts; pay money left over at the end of the month towards the debt with the highest rate of interest
  5. Once that debt is paid in full, apply money left over at the end of the month towards the debt with the next highest interest rate
  6. Repeat, until all debts are repaid.

Option 2: Managing Three Debts

  1. Credit Card A – balance $1000 – Rate 27% – Repayment $30
  2. Credit Card B – balance $2000 – Rate 10% – Repayment $40
  3. Credit Card C – balance $2500 – Rate 15% – Repayment $50
  • Total available for debt repayment is $130 a month
  • Total minimum repayments $120
  • Surplus = $130 – $120 = $10

Under this High Interest Strategy, repayments would be as follows:

  • Credit Card A Repayment $30 + $10 (surplus)
  • Credit Card B Repayment $40
  • Credit Card C Repayment $50

When Credit Card A is Repaid

  • Credit Card B Repayment $40
  • Credit Card C Repayment $50 + $10 (surplus) + $30 (Card A min)

When Credit Card B is Repaid

  • Credit Card B Repayment $40 + $10 (surplus) + $30 (Card A min) + $50 (Card C min)

Results

  • Time until debt free: 60 Months
  • Total paid: $7782.00

Option 3: Paying off Smaller Debts First

Mentally, chipping away at huge debts may make you feel like you’re not getting anywhere. In these cases, a reverse strategy might be appropriate, to give your motivation a boost. Consider this workflow:

  1. List all debts, from lowest to highest balance
  2. Write down the minimum repayment for every outstanding debt
  3. Calculate how much money is left, after making minimum payments
  4. Pay the minimum repayment – plus the leftover cash – on the debt with the lowest balance
  5. After the first debt is paid in full, target the next lowest debt and repeat the process, until all debts are paid

Payment Strategy Example 3: Snowballing

  1. Credit Card A – balance $1000 – Rate 27% – Repayment $30
  2. Credit Card B – balance $2000 – Rate 10% – Repayment $40
  3. Credit Card C – balance $2500 – Rate 15% – Repayment $50
  • Total available for Debt Repayment is $130 a month
  • Total minimum repayments $120
  • Surplus = $130 – $120 = $10

Under the Snowballing Strategy the Repayments would be as follows:

  • Credit Card A Repayment $30 + $10 (surplus)
  • Credit Card B Repayment $40
  • Credit Card C Repayment $50

When Credit Card A is Repaid

  • Credit Card B Repayment $40 + $10 (surplus) + $30 (Card A min)
  • Credit Card C Repayment $50

When Credit Card B is Repaid

  • Credit Card C Repayment $50 + $10 (surplus) + $30 (Card A min) + $40 (Card B Min)

Results

  • Time until debt free: 61 Months
  • Total paid: $7815.00

Based on all of the figures in this article, the strategy that seems to work the best is #3, Paying Off Smaller Debts First. Although not the best strategy by numbers, the psychological boost alone may be worth it, to help you form better habits in order for forge a long and disciplined road back to financial health.

NB: This information is provided for information purposes only. Debt Mediators does not organise nor can advise you on payment strategies.