Here a car loan, since zero percent financing, overdrawing the dispo and making purchases on credit card and before you know it, the realization that you are facing a mountain of debt that is getting harder and harder to pay off. What to do? One solution may be the so-called “snowball method”. But what is the point of this method?
Financing, credit cards, instalment loans, real estate loans: There are many ways to get into debt. And the way into the so-called negative debt spiral is creeping but steady. Once caught in the debt trap, good advice is expensive. However, it is precisely in such a situation that one must keep a cool head and face the situation with determination. For as varied as the way into the debt trap can be, the more diverse the ways out of the debt can be.
The combination of different individual loans into one loan and the corresponding rescheduling of the debt would be a possible alternative. Another is to go to a debt counselling service. Another is the so-called snowball method. But no solution will work without first taking a few important steps.
The preparation to repay loans
In the beginning there is always the realization that we are in debt. For those who do not want to admit debts to themselves or have no overview of the amount of their debts will not successfully pay them off, no matter how they are paid off. Therefore, the most important step is to face up to your financial problems and look ahead – in other words, to start reducing the accumulated debts.
The basic prerequisite is an honest, well-founded assessment of your own financial situation – without any whitewashing! The bare figures from bank statements, bills and credit card statements are moved into a clear list or table: How much is outstanding with which creditor at which interest rate for how long?
Budgeting is also part of the preparation. After the listing of debits and credits, the bottom line is to make clear how much is left each month that you can invest in the repayment of your loans.
With the sum that comes out of this calculation, one must now budget and see to it that the most urgent repayment instalments are increased. This may mean reducing or even deferring others – preferably those with the lowest interest rates – until more urgent loans are paid off. It is of course important not to do this on your own. Agreements and negotiations with creditors are the be-all and end-all.
This is how the snowball method works:
If you have managed to realign your budget and service your loans with more than the minimum installments, you can accelerate this process even further with the snowball method. This method of loan repayment involves initially listing the debts in ascending order from the lowest to the highest liability amount. For comparable loans and credits, the effective annual interest rate should be the decisive criterion. In such a case, the loans should be sorted from higher to lower interest rates in descending order. Then the budget is allocated.
In fact, the rate of the lowest loans is increased as much as possible, while the larger outstanding debts continue to be serviced at the minimum rate or are deferred. In this way, the repayment of the smallest loan is pushed forward, the liability is paid off more quickly. If the debts of the first, smallest loan are completely paid off, the budget plus goes into the next larger loan.
This means that the repayment rate of the second smallest loan is increased by the increased rate of the just redeemed, smallest loan. This accelerates the repayment of these debts as well. As soon as this loan is paid off, the rate of the third is increased by the previously spent fixed rate, and so on until one reaches the most expensive and highest loan. When all the small loans have been paid off, one has more budget available to concentrate on paying off the “biggest chunk”.
And while the bank account and the credit investigation company are happy that the much-quoted small animals, which also make dung, are gradually disappearing, this snowball method also has a psychological effect. With every credit paid off, the reward centre is addressed. This gives you a good feeling and you have more incentive to consistently complete this personal repayment plan.
Anyone who has to repay a large number of smaller loans quickly loses the overview and runs the risk of falling into a debt spiral, from which it is usually quite difficult to escape. Especially if the loans differ significantly in their conditions. In such a case it can make sense to combine all the old loans and redeem them with a new loan. But what are the advantages of such a procedure?
Anyone who is toying with the idea of taking out an instalment loan to pay off outstanding debts is basically doing nothing more than rescheduling. Whether this is worthwhile depends on the individual case. It can certainly make sense if you have to pay lower interest on the new loan than on the outstanding debt to be repaid. So in order to pay off possible credit card debts or an overdraft facility, an instalment or personal loan is often the better choice. It is true that taking out a further loan can also have negative effects on your creditworthiness. However, it can also be advantageous to pay off existing debts with an instalment loan.
Why it can make sense to take out a loan to pay off debts
If you have difficulty paying your installments regularly or if full repayment is unlikely due to high fees and interest rates, a personal loan with a lower interest rate can be a good solution to pay off credit card outstanding debts in full, for example. A loan with lower interest rates could reduce the monthly instalments and thus the financial burden.
This is an important factor for many consumers who have problems paying on time. After all, smaller sums can make it easier for them to meet payment deadlines. At the same time, they have more money left with which to service the new loan and thus pay it off faster.
What you should bear in mind when seeking debt restructuring
Before deciding on a debt rescheduling or a debt settlement by new debts, one should take a close look at the contractual terms. Not only the annual percentage rate of charge should be considered. Also the term of the new loan. Although the payments may be lower than with the initial loan, it could take longer to pay off the new debt, depending on the contract details at maturity. Lower interest rates with a longer term can be more expensive for the borrower in the long run, but at the same time it can keep the Schufa score and creditworthiness in check because the smaller loan instalments are paid regularly.
Private or instalment loans can be a helpful instrument to improve one’s creditworthiness and the Schufa, which has at least suffered until the debt restructuring. In the same way, they can provide some relief in the event of unexpected bottlenecks or major purchases. But because nothing is free in the world, one should know the costs and risks that such a loan involves in case of doubt. Pro and contra lists can make decision-making quick, clear and above all more rational. Anyone who is thinking of redeeming open liabilities with another or different one should first consider their own behaviour in financial matters. Only then does an installment credit for debt reduction really fulfil its purpose.