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Inadequate financial planning can devastate our financial health. Knowing how to manage our debts is essential to keep them under control. Here are two easy and useful methods to pay off debt.
Overindebtedness is a major problem when we don’t keep track of our finances. If we don't make sure our savings are growing at a certain rate and our income matches our spending, our finances will suffer damage that will be hard to fix.
Before we tell you about the debt snowball and avalanche methods, you should develop good habits, so you won't need them and your debt won’t be excessive.
What is digital banking?
Digital banking is the online version of your bank. It consists of the same services at a branch (like customer assistance and opening new current accounts) and custom features to help you manage your finances at any time and anywhere.
Financial management must start with household financial planning. We should know what are regular and occasional costs and income are (including car insurance and university fees). Making a two-column list to categorize what goes into and comes out of our bank account is an easy way in which we can be more aware of our finances.
Aside from making a list, we should also arrange them into categories. Under the “costs” column, we can create sections for things like our rent or mortgage; water, electricity and Internet bills; recurring expenses for transport and food; and “ant expenses” (small sums that we spend every day on things like a cup of coffee, which can add up to a sizeable amount).
If we subtract our costs from our income, we’ll see how much we’re managing to save at the end of the month. The difference should be at least 20%, in line with the 50-30-20 rule: 50% for basic expenses, 30% for non-essential expenses and 20% for savings. If we keep growing our savings, we’ll be more capable of paying unforeseen expenses and setting goals, like buying a new car, without going into excessive debt.
It’s important to follow the 50-30-20 rule. Imagine we’re buying everyday, basic things, like food. To be more efficient and avoid temptation, we should make a list of everything we really need. Once we’re at the supermarket, we should commit to getting what’s on our list.
This means common customer products (like a bank account and credit cards), as well as debt products (like loans and credit facilities). Debt is not a problem if we understand what we need according to our profile. What is a problem is not keeping track of our spending. An digital banking app can be useful to see credit card payments (even though charges occur in a specified time frame).
We should keep a detailed account of our debts. We should also avoid taking on more debt until we’ve settled all others so that they will not pile up and lead us to overindebtedness, which will have detrimental consequences for our financial health.
What are the debt “snowball” and “avalanche” methods?
The debt snowball method entails grouping your debts together and paying them off one by one, from smallest to largest. Because we’ll get more accustomed to using some of our income for this purpose, we’ll have an easier time paying everything off without being overwhelmed by our most sizeable debts. To find out more about this instrument, read this Openbank article (in Spanish).
On the other hand, the debt avalanche method is a more aggressive approach. While it’s true more people give up on it, it makes settling debts faster and saves money on interest. Unlike in the debt snowball method, we settle the highest debts first.
How to follow these methods
The main difference between the debt snowball and avalanche methods lies in order of payment. However, both of them are very similar. We start by listing our debts. Then, we order them from largest to smallest (i.e. debt avalanche method) or from smallest to largest (i.e. debt snowball method) and check if we can make the minimum required payment on each one. Next, we figure out the extra amount we’ll be paying on the first debt we want to settle. With the debt snowball method, minimum required payment and extra amounts for the smallest debt will determine how we go about paying the next debt (with its minimum required payment). Hence, the snowball will get bigger.
The debt avalanche method, where we start with the largest minimum payment, can be more affordable since what we pay gets smaller and smaller. Because our debts are ordered from biggest to smallest, we can settle our debts faster.
Do you know how to consolidate your debts? Read this article (in Spanish) by Finanzas para Mortales (“Finance for Mortals”) to find out.
