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2 ways of eliminating your debts

One of the financial goals many people have is to eliminate all the debts or loans that they have. If you can’t eliminate them, then the next goal is to reduce the amount slowly and hopefully in a few years, the debts or loans will be gone. But the problem that I notice with most people is that, there will always be at least 1 debt or loan. We are hardly debt or loan free! Maybe there are few such people, but they are fast becoming extinct.

Anyhow, this does not change the fact that most people still want to eliminate or reduce their debts, myself included. So I went online and did some research, and realized that there are basically 2 types of approaches in eliminating debts.

• Eliminate the one with highest interest rate
• Eliminate the one with the smallest outstanding balance

Each has its pros and cons. Mathematically speaking, the first option which is to eliminate the one with the highest interest rate would be a better option in order to eliminate the total outstanding amount.

For example, if you have the following debts or loans (just estimations and the interest rates might not sound realistic to you):

• Car loan – RM 50000 at 3%
• Study loan – RM 60000 at 4%
• House loan – RM 200000 at 5%
• Credit card balance – RM 2000 at 10%
• Computer installment – RM 3000 at 2%

If you were to use the first option (eliminate highest interest rate first), it will appear like this.

• Credit card balance – RM 2000 at 10%
• House loan – RM 200000 at 5%
• Study loan – RM 60000 at 4%
• Car loan – RM 50000 at 3%
• Computer installment – RM 3000 at 2%

But if you are going for the lowest outstanding balance first, it will look like this

• Credit card balance – RM 2000 at 10%
• Computer installment – RM 3000 at 2%
• Car loan – RM 50000 at 3%
• Study loan – RM 60000 at 4%
• House loan – RM 200000 at 5%

If you are following the first option, one warning to you – you need to be a highly disciplined person and pay your loans on time EVERY TIME. Because if you don’t do that, you will incur more damages that you possibly wanted. And most importantly, you will start feeling demotivated because even with all the hard work and cost-saving things you’re doing, you are still unable to pay off anything completely. It is a very big psychological blow and it is the last thing you want while trying to clear your debts.

That’s why some experts recommend the second option and to remove the debts one by one COMPLETELY. Pay the minimum amount possible for all the other debts (in order to avoid getting extra interest charges), and pay more (whatever balance you can squeeze from your monthly income) to the one with the least amount. That way, you will feel more motivated especially if you can manage to remove 1 or 2 debts completely from the list. It is a very good psychological boost.

I am not sure whether this will work for everyone since it does force you to pay more than the traditional way of eliminating debts. But in a year when most experts are being pessimistic, having a shorter list of debts is always a good thing to have.

If you’re still unclear about what I’m explaining here, maybe the following link can help. After all, I did my research based on the link below.

Two Approaches to Debt Elimination

Hope it helps!

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