- Atahualpa Amerise
- BBC News World
8 hours ago
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Mortgages, cars, appliances, credit cards… Debts pile up and without knowing how, we have the rope around our necks.
This is happening to more and more people around the world.
Global private debt rose by 13% of global GDP (gross domestic product, the sum of a country’s goods and services) in 2020, the largest increase in the last two decades, the International Monetary Fund (IMF) said this month.
In some Latin American countries, the majority of the population owes money to financial institutions, including Peru, where more than seven in 10 people said they were indebted, according to a recent survey by consulting firm Datum.
And in the United States, credit card debt hit a record $890 billion this month after growing $100 billion in a single year, according to the Federal Reserve.
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When payment obligations pile up, many debtors use strategies to meet their obligations as smartly as possible.
When payment obligations accumulate, many debtors employ strategies to meet their obligations in the smartest way possible.
Two of the methods most recommended by experts are known as “avalanche” and “snowball”.
Below we explain what they consist of.
the avalanche
If you are a balanced, patient, and calculating person, your strategy is the avalanche.
First you need to make a list of all your debts and rank them in highest order. at the lowest interest rate.
Your goal is to pay the minimum required by everyone.
And for the one with the most interest, commit as much extra money each month until you pay it off.
For example, if your mortgage is 8%, the television you bought is 12%, your car is 15%, and your credit card debt is 25%, contribute as much as you can to pay off the latter, always keeping the minimum one payments the other.
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Watching debt build up over time can be demotivating and hamper your efforts to reach your desired zero balance.
Once you’ve settled your credit card balance, use your extra budget each month to pay for the car, then the TV, and finally the mortgage.
The effectiveness of the avalanche lies in the interest rates, which make up a significant portion of the monthly payments on most loans.
The higher the interest rate, the more money is used to cover interest costs and the less equates to principal or the value of the product itself.
This method saves you money by preventing accounts with the highest interest rates from going into debt indefinitely. Math doesn’t lie.
the snowball
But math is not everything.
A debt situation can cause a high level of stress, so psychology is a factor to consider.
Watching debt build up over time can be demotivating and hamper your efforts to reach your desired zero balance.
Take the case above: you have a $100,000 (about 515,000 real) mortgage, you just bought the TV for $1,000 (about 5,500 real), you have $5,000 (about 5,000 real) on credit cards.
If your first goal is to pay off credit card debt but your income is tight, it can take years to get there, and without strict discipline, you could throw in the towel halfway.
Then you can opt for the snowball strategy.
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The socalled snowball method involves prioritizing debts with a lower value
First, list your debts as in the previous case, but rank them by value rather than interest rate.
Sure, make the minimum payments for everyone, but invest as much extra money as you can to cover the lower ones until you pay.
In that case, you should do your best to pay for the TV first.
An achievable goal, right?
If you achieved the first goal, you would soon see the results of your efforts, which would further motivate you to keep paying your car, credit card, and mortgage, in that order.
Although the snowball is mathematically less efficient than the avalanche, experts say it can achieve equal or better results.
There is also the possibility of combining both methods: pay off the smallest debts first and, with the motivation of the first success, move on to the avalanche strategy to deal with the rest of the debts.
It is important to manage your debt well
For the Mexican academic and financial expert Norman J. Wolf, both strategies can be valid as long as there is a stable income.
And if you’ve accumulated a very large amount, “another reasonable option is to consolidate the debt into a single bank,” he says.
In an interview with BBC News Mundo (the BBC’s Spanish service), Wolf, who is a professor at the National Autonomous University of Mexico, offers some advice on how to manage your debt in the smartest way possible.
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The avalanche method requires you to make a list of your various debts and rank them from highest to lowest interest rate.
“The first step is to know what we are hiring when we buy something. It is necessary to look at the payback table and, if you do not understand it, ask a specialist for advice.”
This table shows all payments to be made for the loan, e.g. B. How much principal and interest has to be paid and what the outstanding debt is in each period.
“In the long run, what we’re looking for first is principal amortization: being able to make large payments that amortize the balance due, and so interest rates go down,” says Wolf.
The specialist guarantees that in an inflationary moment like the current one, it is best “to give priority to amortizations where more capital is paid first and interest is left at the end”, data to be included in the amortization table .
And if he has to choose between snowball and avalanche, he tends towards the latter.
“You can see what the most aggressive interest rate is, and I would say pay off the debt with the highest interest rate first, and then pay off the debt with the lowest interest rate.”
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