Do you have various loans? How to plan loan repayments in a better way? Which loan is first to finish and what strategy do we have to follow? Whether we must continue investment along with loan repayment? These are the various questions that many of us face. Let us try to answer them in this post.
Many of us in one way or another way have certain kinds of loans. They may be personal loans, home loans, or credit card loans. If you have various kinds of loans, then how do you plan to pay them?
Before jumping into plan loan repayments, first, follow these steps.
# Have a proper emergency fund in place – Ideally one must have at least around 6-24 months of expenses. Hence, if you have a surplus and plan to repay your loans, first make sure to create an emergency fund.
# Have Life, Health, and Disability Insurance in place – Along with an emergency fund, make sure to have sufficient Life, Health, and Disability insurance products.
# Try to concentrate on mandatory goals – If you have a surplus, then it does not mean that you repay your loans aggressively (again it depends on what type of loan you have). Try to balance the investment between your mandatory goals (like kid education and retirement goals). If you still have a surplus, then start repaying the loans aggressively. However, this rule to a certain extent can be broken if you have high costing loans like credit cards or personal loans.
How to plan loan repayments?
In the finance world, there are two strategies to plan loan repayments. The first one is the “Snowball Method” and the other is the “Avalanche Method”. Let me explain both.
# Snowball Method
The steps are explained here.
- Make a list of all your loans. Collect the payment information, outstanding balance, interest rate, loan tenure, and due dates.
- Sort the list based on the smallest to largest outstanding loans.
- Start repayment at first with the smallest outstanding loan.
- Once this loan is over, then concentrate on the next smallest outstanding principal balance loan.
# Avalanche Method
- Make a list of all your loans. Collect the payment information, outstanding balance, interest rate, loan tenure, and due dates.
- Sort the list based on the highest interest rate to the lowest interest rate loans.
- Start repaying with the highest interest rate loan at first.
- Once this loan is over, then concentrate on the next highest interest rate loan.
The Snowball method allows you to feel WIN as and when you clear each loan (even though how small the loan is). However, the Avalanche method is more of a practical view. Here, you are getting rid of the loan which is costing you more. Hence, the Snowball method is more of happiness and the Avalanche method is more of a financial approach. Which one to follow?
In my view, I strongly suggest you do not follow both methods. Instead, we have to follow more of a conscious our own strategy. You noticed that both methods are SILENT on the tenure of the loan. You may be well aware that during the initial tenure of the loan, you are paying high interest and as the loan is nearer to close, it will reduce drastically in your EMI part. Hence, follow the below approach.
# List all the outstanding loans with the details like when you started, current outstanding, interest rate, and are there any restrictions towards the loan repayments.
# Chose the loan which is charging you a higher interest rate.
# However, if the loan tenure has already been completed by more than 50% or more, then compare it with the next higher-costing loan which one is feasible to close early. Because in the first loan the rate of interest is high. However, you already benefited the lender in a big way by completing almost more than 50% of your loan tenure. Hence, you have to check the pros and cons by comparing them with the immediate next higher-rate loan.
# If your loans are like credit card loans, educational loans,s or personal loans which are more than 8% to 9%, and they are all new loans, then for time being pause your investment (no matter whatever may the goal type like kids education or retirement goal). Concentrate at first on repaying all these high costing new loans.
# If you and your spouse both are working in a different industry and luckily you feel losing your job is the rarest of rare cases, then you can use your emergency fund also towards loan repayment and start building immediately with whatever the EMI you will save. However, this strategy may backfire sometimes if you face any emergency before you again reach your emergency fund mark and you don’t have sufficient financial assets to sail through that emergency. Hence, I personally do not suggest this strategy.
# Last but not least, never continue your home loan for the sake of tax saving. If you think logically, you are not saving any tax there.
Conclusion – From all these above points, you noticed that no standard process fits to all of us. As it is personal finance, you have no option but to personalize based on your situation. Hence, you have to take an informed decision based on the above pointers. If you are not capable of doing it on your own, then hire an unbiased fee-only financial planner.
