Kambatuku Mekupi
After a brief delay, we have recognized the need to initiate financial management for farmers and aggregators, particularly in light of the current state of the economy and the steadily increasing interest rates.
The key question that arises is: How can we effectively manage our debt to ensure that it does not disrupt the agricultural business processes?
There are several methods to manage debt effectively, but before delving into them, it’s essential to remember that cash is king. Managing cash flow is crucial for meeting business obligations and ensuring funds are available for operations.
Two popular strategies for debt management are the Snowball and Avalanche methods, each offering unique approaches to paying off debts while maintaining control over your finances and cash flow.
Debt Avalanche Method
The Debt Avalanche method doesn’t prioritize the value of the debt; instead, it arranges all your debts based on the interest rates, listing the highest interest-bearing debts first. This method focuses on paying off the debt with the highest interest rate initially.
As you may know, the interest rate significantly impacts how quickly you can pay off or negotiate a debt.
Snowball Method
With the Snowball method, you concentrate on paying off all your debts, with a primary focus on the smallest one while having the option to double or increase the installment while paying off the remaining balance in full.
Once you’ve cleared the first debt, you move on to the next one, continuing this process until all your debts are paid off. The key is to apply the installment you used for the first debt to the next one, gradually increasing it each time.
The Snowball technique is similar to the Avalanche method, as it starts by prioritizing the loan with the highest interest rate. However, it emphasizes increasing or doubling the installment for the first debt in line and then transferring the remaining balance to another debt until it’s paid off.
Always remember to make an extra payment on the first loan you intend to pay off and continue this process until it’s fully settled.
Let’s illustrate how these methods work with a practical example.
Suppose you have the following debts:
- Student Loan: N$30,000 with a 6% interest rate.
- Credit Card: N$5,000 (19% interest rate)
- Personal Loan: N$10,000 with a 17% interest rate.
- Auto Loan: N$90,000 with an 11% interest rate.
- Mortgage: N$800,000 with a 12% interest rate.
Using the Debt Snowball Method:
- Step 1: Pay off Credit Card (N$5,000)
- Step 2: Repay Personal Loan (N$10,000)
- Step 3: Settle Student Loan (N$30,000)
- Step 4: Clear Auto Loan (N$90,000)
- Step 5: Pay off Mortgage (N$800,000)
The Debt Avalanche Method may prioritize debts as follows:
- Step 1: Pay off Credit Card: N$5,000 (19% interest rate)
- Step 2: Repay Personal Loan: N$10,000 with a 17% interest rate.
- Step 3: Settle Mortgage: N$800,000 with a 12% interest rate.
- Step 4: Clear Auto Loan: N$90,000 (11% interest rate)
- Step 5: Pay off Student Loan: N$30,000 (6% interest rate)
Another option to consider is paying off the debt with the highest monthly installment to boost your profitability. Depending on your financial situation and personal preferences, you can decide which strategy to use between the Debt Snowball and Debt Avalanche methods.
The Debt Snowball method provides a psychological boost as you achieve small wins when paying off smaller debts, while the Debt Avalanche approach might save you more money in the long run by minimizing interest payments.
Disclaimer: Your loan details may differ from these examples as they are subject to monthly changes, including interest rates, monthly payments, and outstanding balances.
Kambatuku Mekupi is a Managing Consultant at Simpli Business Advisory and can be reached at [email protected].