Credit cards, depending on how you use them, can be a boon or bane. If you use them judiciously and pay the entire monthly bill before or on time, they can give you many benefits. Some of these include a free credit period of up to 50 days, instant discounts, reward points, and other benefits. However, if you use them for splurging and are unable to pay the entire monthly bill, you will end up paying a huge interest rate, usually in the 36% to 45% p.a. range.
The same goes with personal loans, if not used properly, although the interest rate is much lower than credit cards. It can put people in a debt trap. In this article, we will understand how an individual can get out of a debt trap using various debt repayment strategies like the snowball method, avalanche method, etc.
If an individual has an outstanding balance on their credit card(s) and cannot repay it, they should reach out to the bank to convert it into an EMI plan. If you just pay the minimum amount or additional amount, but not the entire outstanding, the bank will charge late payment fees and a monthly interest, usually in the 3% to 3.75% range. If the outstanding amount is large, the fees and interest charges will balloon, and it can become a debt trap.
Hence, the individual should connect with the bank officials and ask them to convert the credit card outstanding into an EMI plan. The EMI plan will help in two ways:
All banks may not give you the option to convert the credit card outstanding amount into EMIs. In that case, you may use any of the debt repayment methods explained below.
In this debt repayment strategy, you list down all the outstanding amounts for all credit cards, starting from the lowest to the highest. Make the minimum amount due payment for all the cards. Post that, from the balance available, pay the outstanding amount for the credit card with the lowest balance. After the repayment, you can strike out that credit card from the list of cards with outstanding balances.
With one card removed from the outstanding dues list, you score a victory. Next month, pay the minimum amount due for all cards. Post that, use the balance available to repay the outstanding amount for the next card with the lowest balance.
As you continue repeating the same process every month, your overall debt will reduce. The balance available for repayments will grow every month like a snowball month after month. The small wins of striking out a credit card every month or every few months from the outstanding dues list will motivate you to keep going till you repay the entire outstanding debt for all cards.
In this debt repayment strategy, you list down all the credit cards in the order of the one with the highest interest rate to the lowest. Make the minimum amount due payment for all the cards. Post that, from the balance available, pay the outstanding amount for the credit card with the highest interest rate.
Depending on the outstanding amount, you may or may not be able repay the entire amount in a single month. If not, pay the minimum amount due for all the cards and the remaining amount for the credit card with the highest interest rate. Repeat the process every month.
Once you repay the entire outstanding for the card with the highest interest rate, strike it out from the list of cards with outstanding balances. In the next month, after paying the minimum dues for all cards, target the credit card with the next highest interest rate.
The debt avalanche payment method helps you save on interest amount paid every month by targeting the card with the highest interest rate. If the outstanding amount is large, it may take some time for you to see the progress/results. If you have the patience, you should go with this debt repayment strategy.
While both repayment strategies are widely followed, the one you should adopt depends on your needs. If small wins excite you and keep you motivated, consider the debt snowball payment strategy. If you have an analytical mind and are patient enough, you may consider the debt avalanche payment strategy. An individual can even use a combination of both strategies. So, it totally depends on your needs.
Some of the other factors to keep in mind while doing debt repayment include the following.
While credit cards provide several benefits, you should use them when you are confident that you will be able to repay the monthly bill. If you are unable to pay the monthly bill, the benefits may not be worth it. Hence, always use credit cards judiciously to prevent falling into a debt trap.
Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.
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