Manage debt decision better, thereby better manage your debt. The decision to take on debt or not, pay off this debt first or not or even recognizing that you are way over your head in it is only start of the decision points you may face throughout the debt process. The aim is to not be one of those Kenyans buried in 70% interest debt because we didn’t make better decisions.
Let’s not chalk it up to ignorance.
Borrowing
It is not always a good idea to get into debt, however, borrowing sometimes is unavoidable. For instance, you may want to take out a mortgage loan since you don’t have the cash to pay for you house upfront or would hold up too much of your cash. You may also, borrow to complete paying school fees or whatever the pressing need may be at the time. Whatever the case, if you are thinking of taking loan, here are several things you need to do before you borrow.
Note: Without these things, it will cost you.
1. Establish How Much You Need
Borrowing will always cost you money because you have to pay interest. Also, you are committing future unearned income to pay it back, therefore you won’t be able to do other things with you money.
Hence, limiting how much you borrow is important so that you don’t over-commit your unearned income to landers and make it harder for you to achieve your financial goals. Therefore, you’ll need to:
- Evaluate your need to take out a loan. How necessary is it for you to borrow to say things like a big wedding? You shouldn’t borrow to finance a wedding – just save up and pay cash instead. Therefore, you should only borrow when its pressing or when it improves your financial standing i.e. paying for a house or education.
- Borrow the minimum. Don’t overextend you need, take out the least amount you need to achieve the goal you need to accomplish.
The goal is to maintain a manageable level of indebtedness and avoid sinking into debt. The last thing you want to do is make debt a major financial problem in your life.
2. Understand the loan product
Before you take out a loan with any financial institution, you need to know and understand the following:
- What is the interest rate? Consider both flat interest rate and reducing balance calculation methods that the institution may offer.
- Is the interest rate fixed or flexible? Consider whether you can still afford the loan when the interest rates are readjusted upwards.
- What is the total cost of the loan? Always request for the loan amortization chart. It will put into focus that actual cost of the loan by providing a full picture of the principal and interest paid to be paid well into the future. You do not want to be one of those borrowers to pays too much for credit or even default on a loan.
- How long do you have to repay the loan?
- What are the monthly payments?
- What fees, if any, will you be charged? Fees can increase the cost of the loan, ensure you understand the fees you are likely to incur at each stage.
- Will you be penalized for paying off the loan ahead of schedule?
3. Compare Lenders
I understand that you cannot just walk into any financial institution and take out a loan. Most financial institutions will want to first establish a history with you before they can lend to you. you. This is perhaps is one the of primary reasons that people opt takeout loans with non-deposit taking unregulated micro-financers that charge exorbitant fees and interest.
However, lets build options. Have them before we need them.
There are a lot of variations among lenders in terms of rates and fees – banks, credit unions and even online lenders. When you shop around, try to see if lenders will give you details about the loan you could qualify for before making any hardline decision.
Learn More: How To Build A Good Credit Score
4. Budget Repayments
Borrowing means that you commit future unearned income to make specific repayments for a certain period of time as stipulated in the terms of your loan. Therefore, it is essential that before you agree to commit to this level, you can afford to make payments for the entire life of the loan.
Budgeting your payments will help you see whether you can actually afford the loan or not. After you have settled on a lender, take the monthly cost they provided and work it into your budget. Make sure you can easily afford the loan without too much strain or hustle. The last things you want to do is risk defaulting and destroying your credit score.
To ensure that its the right decision, consider living on this new budget for a period before you commit. This will help you see whether you handle it.
Managing Debt
If you have multiple debts with different terms and interest rates, how well do you manage it? Are you looking to reduce the cost of debt or the number of debts? How well do you allocate limited resources to repay the debt? A high level of debt and high-interest rates contributes to financial instability. With high debt and interest, it becomes harder to save for the future and handle emergencies. Therefore, if you are already in debt, the aim is to minimise the cost of that debt.
So what are some of the things we can do to ensure that we are managing our debt optimally:
- Automate Payments. Why? Intuitively, even the best of us, we are more likely to manage multiple debts in ways that cost us more. Psychologically we are inclined to pay off the smaller debts first as opposed to the debts with the highest cost. This is because we are more motivated to reduce the total number of debts we have rather than reducing the overall cost associated with the debts. Therefore, by automating debt payments we able to remove the human element in our decision making and allocate money optimally.
- Refinance Debt. This is an easy way to minimize the cost of debt by consolidating it into one. By combining your existing debt of varying interest rates reduces the overall cost of the debt.
Learn more: How to Overcome Debt Fatigue
Reducing Your Indebtedness
When you have a lot of debt, you need to put in a lot more effort to ensure that debt doesn’t take over your life. To so, you’ll need to reduce your need to take on more debt and pay off all existing debt.
- Set-up an Emergency Fund. Without access to savings, you’ll find yourself needing to borrow to cover emergency expenses. To reduce future indebtedness, you’ll need to work your way to building a sufficient emergency fund to cover emergencies.
- Make minimum payments. No matter what you do, ensure that you have made at least the minimum payment on your debt. This will keep your account in good standing and help you avoid late fees. Also, try not to miss any payments. When you miss a payment it becomes harder to catch up and may lead to an eventual default.
- Prioritize High-Cost Debt. Make a list of all the debt you have and rank the debt in order of interest cost. Make minimum payments all the debt, but devote a little more the debt with the highest interest. This strategy will reduce the overall cost of debt held and is commonly referred to as Debt Avalanche.
- Maintain a budget. Keeping a budget ensures that you have enough money to cover expenses. You can plan ahead and take action early. This will help you avoid taking on debt to meet your monthly expense. A budget can also help you identify extra money with can go towards setting up an emergency fund or pay off you debt faster.
Learn More: How to Get Out Of Debt Successfully
Buried in Debt?
Sometimes we may find ourselves way over our heads with debt and other bills. It is good to recognize that you need help and seek help from a debt relief institution. So, if you find yourself buried in debt, here are some options to dig you way out.
Debt relief options:
- Debt consolidation. Debt consolidation will simplify your finances to only one payment. It will help you pay off higher interest debts and leave you will lower interest debt.
- Counselling. If you can’t seem to stop borrowing and think that you have a spending problem. It’s good to seek help and get yourself under control before debt ruins your life.
- Debt settlement. Not the most desirable debt solution, but works when you are out of options. With debt settlement, you typically make lumpsum amount or multiple payments to settle the outstanding debt paying less than you owe.
- Bankruptcy. If you can no longer meet your debt obligation to lenders, you can file bankruptcy. When you file for bankruptcy, you discharge your debt and are no longer liable for it. This, however, doesn’t cancel the debt. Instead, a trustee is appointed to manage your assets in order to facilitate repayment of the existing debts.
Learn more: 5 Effective Ways to Get Out of Debt Quickly
Why Don’t People Manage Debt Better?
People manage debt the best way they know-how. They make the best decisions based on the information on hand – right or wrong. The way we make decisions around finance will either set us up on the right path or the wrong path. Psychology and culture play a big role in this. Understanding our proclivities to make x decision over y, will help us forge better decision in the future. Therefore, I want to challenge you to make better decisions and manage debt better from here on out.
Remember high debt and interest contributes to financial instability.
Happy Building!
Image credits: Top by Pixabay via Pexels.
Article Source:
- Scientific American. “Why Don’t People Manage Debt Better? , https://blogs.scientificamerican.com/mind-guest-blog/why-don-t-people-manage-debt-better/.” Accessed on 28th November 2020.