Did you know that the total personal debt in the UAE is over AED 420 billion*? And the total household debt in the UAE represents two-thirds of the total household debt in the GCC.
Personal debt comes in various forms – credit card debt, mortgages, car loans or personal loans. Having a reckless attitude towards debt, can eventually overwhelm you with more debt than you can manage to pay off comfortably. Loans should be taken only for necessities or productive use, rather than to fund frivolous spending. If you already have loans, how do you get rid of them faster and most cost-effectively?
Your loans may vary in terms of interest rate, outstanding balance, tenure and terms. One of the biggest reasons why borrowers end up defaulting on loan repayments is because they miscalculate the ones they should be settling sooner. Here are some repayment strategies to help you become debt-free quicker.
‘Debt stacking’ – How does it work?
Debt stacking is a loan repayment method which helps you get rid of the most expensive loan you owe, sooner. This is how you can use debt stacking:
- Rank all your loans based on interest rate in a descending order. Your aim is to pay off the top ranking loan, with the highest interest rate first.
- Keep paying the standard installments on your loans and minimum amount due on your cards every month. Avoid any late payment fees.
- Next, use the extra money left over or your monthly savings towards paying off the loan which ranks first.
- Once you settle one loan, use the amount you were paying towards that, to settle the next loan on your list. Continue doing so till you’ve paid off all your loans.
Debt stacking helps in dramatically cutting down the time you would take to settle your loans, along with reducing the total interest you would pay.
For example, let’s assume you have an ABC bank credit card with an outstanding balance of AED 5,000 (at an APR of 25%) and another credit card from XYZ bank with AED 10,000 balance (at an APR of 30%), a car loan balance of AED 40,000 (at 6% p.a.) and a personal loan balance of AED 50,000 (at 4% p.a.).
Under the debt stacking method, you would rank them as follows, and aim to pay off the first one on the list before moving on to the next:
- XYZ bank’s credit card at 30% p.a.
- ABC bank’s credit card at 25% p.a.
- Car loan at 6% p.a.
- Personal loan at 4% p.a.
Now you can pay off the liability with a high interest rate faster and save the money that would otherwise have been spent on the exorbitant interest amounts.
What should you be aware of?
When using debt stacking, if the loan with the highest interest rate is the one with the highest outstanding amount, it may take you much longer to pay it off. It can be demotivating to keep using the majority of your savings towards paying it off, without seeing it being checked off your list for very long.
Alternative methods – ‘Debt snowball’
Under this method, you rank your loans in an ascending order, based on the total amount outstanding. While, you continue to make minimum payments towards your loans, your aim is to use the extra money to pay off the smallest loan. Since the outstanding balance on this loan is low, you will be able to settle it faster and thus wipe it off your books faster too.
Taking the same example as used in debt stacking, you would now be paying off the AED 5,000 outstanding balance on ABC credit card first, moving on to paying off the AED 10,000 on XYZ credit card next, and so on.
What should you be aware of?
Keep in mind, debt snowball is not as cost-effective as debt stacking. This is because the smallest loan which you want to pay off first, could also be the one with the lowest interest rate. This would mean, that you’ll be forced to keep more expensive loans on your books for longer, and keep paying heavy interest on those.
Before you choose a loan, make sure you compare the options available in the market. Making a smart decision at the start, can save you from financial woes later.
*Figures as of 2013, as per a research by Strategic Analysis