How to Get Debt Free

Taking inventory of all debt. In an excel sheet, stack them in order of interest rate, and size (amount of outstanding).

1. Credit card debt

2. Personal loans

3. Education loans

4. Vehicle loans

5. Home improvement loans

6. Loans taken from family/friends

How to Become Debt Free in India

Home loans (this you can avoid putting in this list since the tenure could span over a decade and you get a substantial tax break on interest paid and principal repayment).

Step 2: Consider the Debt Avalanche Strategy: Pay off your debts in order from the highest interest rate to the lowest, regardless of balance.

Say you have a credit card outstanding bill of Rs 40,000 at 24% per annum interest rate. But your personal loan is 18% per annum. This strategy would need you to pay off your credit card bill with priority as it has a higher cost. Once you clear that, you move on to the next most expensive outstanding.

How to Become Debt-Free in 5 Years

But it does not imply paying off one loan to the exclusion of another. Make the minimum payment on each loan, while the extra money you have managed to save should be channelized into the one with the highest interest rate.

Step 3: Consider the Debt Snowball Strategy: This time, the size of the debt becomes the focal point, not the cost of it.

Make the minimum payment on each loan, while the extra money you have managed to save should be channelized towards clearing the smallest debt. Once that is paid off, you move to the next one, and the next, until you are debt-free. If you have many loans, this is a good way to clear the clutter.

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Step 4: Which is the right one?

Pay-the-smallest-debt-first is a straightforward strategy that can provide you with the much-needed motivation you need to get started. The small win can help you stay on track. But it also means that getting rid of the smallest debt entails holding onto the debt with the highest interest rate longer. This translates into paying more in interest.

The math favours this Avalanche Strategy, but if the Snowball Strategy helps you actually achieve the goal of being debt-free, there's value in that, too. The Snowball Strategy helps you take the first small steps and is kind of a behavioural trick, the idea being that taking small steps can lead to a sense of motivation and empowerment. It gives you a sense of control and achievement.

Or, you can try a combination. You can work at eliminating the smallest loan first to keep you motivated. After getting one or two out of the way, you can switch to tackling the most expensive debt. A word of caution here: Have a written plan that you adhere to. Or else you will be switching between the two constantly and not make much progress.

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