Why Are Small Debts So Problematic?
The concept of credit utilisation is extremely critical for improving your credit scores. Credit utilisation is the ratio of the total credit line available to you versus the total credit you have utilised. If this ration is higher because of any reasons, then bankers and lenders feel that your lifestyle isn’t affordable to you. This makes you a high-risk borrower. On the other hand, if it is zero, your account is considered inactive, and therefore your credit score will get affected again. Therefore, while it is ideal for keeping the credit utilisation ratio at the minimum, it should not be completely zero as well.
Eliminating Small Debts
Small debts usually take the form of lifestyle debt as against debts for capital assets such as loan against land, building or vehicles — any loan against property. One of the most common lifestyle debts is credit card debt. Now, while the loan against property tenure tends to be big, its interest rates tend to be small.
APR for Lifestyle Loans
Smaller term lifestyle debts usually have high APR. Therefore, if you’re making the minimum required payment, you’ll end up spending just as much in interest payments over the medium term. It can affect the credit scores, making your interest rate higher for other loans against property.
Paying off Small Debts
There are several methods to get rid of small loans. All of them require immediate payment. How you do that though, varies.
Debt Avalanche
In this process, you pay off the loan that has the highest interest rate first. Doing this will reduce your interest burden over a longer time. But doing this means the result will be seen over a long time because paying off the higher interest amount means paying off a higher chunk of your debt, which can take time. Besides, since the loans that are the smallest are the ones with high APR, this can snowball into being left with a higher principal, and therefore, more payments over time.
Debt Snowball
In this process, you pay back the loan that is the smallest amount. In doing this, you leave money aside to pay back the larger ones over a longer period. In doing this, you can see the difference almost immediately as your debt burden keeps decreasing. Psychologically, you know that this would make a difference in the long run. But the problem with this is that if you don’t take your interest into consideration, your higher principal can directly translate to higher payments over time.
Balance Transfer
This process basically involves transferring the debt to another source with a lower APR. For credit card debt, this basically involves, transferring it to a new card that has 0 APR for a period. In this period if you can pay it off, then you’ll be left with money to pay back your loans.
Considerations for Paying Back
The most important thing is the interest’s payment over time. You need to consider the average time that you can pay it back by, your income sources by then, and the various options, each evaluating what your payments will be. That will help you determine the right course.
