Credit can be useful under certain conditions, to meet unforeseen expenses and life projects. But if we are not careful, and we live on credit, we can chain these credits and quickly find ourselves in debt. However, being in debt is not an easy situation: between the various reminders from creditors and the letters from bailiffs, you have to be able to take the bull by the horns to get out of this bad patch, namely to repay your loans! There is no miracle recipe… Exit therefore the repurchase or the consolidation of debts, or even the repayment of credit by making another credit. You will have to repay your debts and that’s good, there is a method that allows this quickly.
Discover a method that allows you to pay off debts quickly. It is called the snowball method.
Step 0: Understand the principle of good and bad debts
Not all debts need to be repaid: only bad debts do. Bad debt is a debt contracted (consumer credit, revolving credit, etc.) to buy a property that loses value and does not bring in money. Example: car, smartphone, high-tech equipment, marriage… Good debt is a debt contracted to buy an investment – real estate, SCPI… – which brings in more money than it spends. Now that we have understood that, we will focus on repaying bad debts.
Step 1: Build up precautionary savings
Before considering repaying your debts, you must first build up precautionary savings. These precautionary savings will allow you not to dig deeper into your debts. Precautionary savings are there in the event of a hard blow: divorce, unforeseen expense, water damage, etc. If you use money from your checking account to pay off this type of debt, you can make your situation even worse. With precautionary savings, you are calm and you can see it coming. Precautionary savings must represent 3 to 6 months’ salary. This means that you can live for 3 to 6 months if you do not receive a salary! Let’s imagine that your salary is 1500€: you must therefore have a minimum of 4500€ aside, and you can even go up to 9000€. The savings must be placed in an unblocked investment, such as the Livret A for example so that you can quickly withdraw the funds in the event of an unforeseen expense. Once the precautionary savings have been built up, you can repay your debts.
Step 2: Calculate your budget and find a greater repayment capacity
To be able to repay your debts, you will have to find a repayment capacity. You will therefore calculate your budget and analyze your expenses with a magnifying glass. If you are living short and you have incurred debt, it is on the side of your budget that you have to look. The objective is to reduce or even eliminate certain non-essential expenses, in order to free up your repayment capacity, which will allow you to repay your debts more quickly. Renegotiate your insurance contracts, compare the prices of your subscriptions, sell your car if it is on LOA and you only use it on weekends, go to work by bike if you have the possibility… When you will calculate your budget, write down all your expenses. So you can see where your money is going. What “unnecessary” or “non-essential” expenses do you incur each month? How much do you spend on shopping, restaurants, etc. ? Calculating your budget each month will allow you to analyze your expenses closely, and you can find solutions to reduce your expenses.
To be as precise as possible, you will calculate your budget using the zero-based budget method. The objective is thus to calculate each month its budget according to its income, then to distribute the money in terms of expenses (variable expenses, repayment of your debts, savings, etc.). Each euro earned must be allocated to a charge: the result of the calculation of your budget must be zero.
Thus, each month, depending on your income, you will have a certain repayment capacity to pay off your debts more quickly.
To increase your repayment capacity, you can also consider taking a second job for a while, and/or selling items that you have at home and that you no longer use such as books, furniture, toys, etc.
Step 3: Write down all your debts and analyze your debt ratio
In an Excel file, write down all your debts and income, including the following information:
- credit organization;
- total amount to be reimbursed;
- credit end date;
- monthly loan payment;
- type of credit;
- reason for credit;
- interest rate ;
- household income;
- debt ratio.
We have created a table which you can download here:
The debt ratio is one of the best-known criteria used by banks to decide whether to lend you money and minimize their risk of default. Indeed, a bank will not finance you if you exceed 33 to 35% (depending on the banks) of debt ratio. Why ? Because she thinks that beyond this percentage, there is a risk for her that you will not repay the loan, because you also have other charges to pay. If the bank applies this rate, it is not without reason… This allows you to continue to live decently and to be able to repay your loan every month!
You must think like the bank, and ensure that all of your credits do not exceed a maximum of 35% (the table automatically calculates this amount). The lower your debt ratio, the better! The higher it is, the more you risk being in debt, for information we start talking about over-indebtedness from a debt ratio of 50%. This rate should be like your bell to tell you that you have to change things and do it quickly!
Being able to put all your debts on paper or via our Excel file will allow you to have an overview and the amount you still have to repay, the monthly payments you have each month. You can then use the snowball method to pay off your debts quickly.
Step 4: The Snowball Method
Now that you have noted all your debts on the Excel file, we will tackle the repayment of these debts using the snowball method. It was popularized by a famous personal finance coach named Dave Ramsey. What is the snowball method? Concretely, you will repay the smallest debt (in amount) first.
Indeed, you will start with the smallest monthly payment you have. You will repay this debt with the repayment capacity you have just created (see step 2). To do this, you will first filter your debts via the Excel file, displaying the smallest debt at the top: click on “sort from A to Z”.
Why attack with the smallest? Because in terms of satisfaction, it is more rewarding to pay off a debt quickly, rather than starting with the biggest one and spending months or even years on it.
Once you have repaid the first debt, use the amount released to repay debt number 2. Then the new amount that will be released from it to repay debt 3, and so on!
At first, it will be hard… but once you have repaid your first debts, your repayment capacity will be greater and greater and you will therefore be able to repay your following debts more quickly, hence the snowball.
With this method, the interest rate is not important, only the total amount remaining to be repaid matters.
If you have 2 similar debts, with an almost identical amount remaining to be repaid, repay the one with the smallest monthly payment first. Always stick to the principle of repaying the smallest debt first.
Solutions to avoid falling into this situation again
Going forward, here are the questions you should ask yourself before taking out new debt:
- Is it good debt?
- Do I really need this latest trendy high-tech gadget?
- Can I wait a few months to make this expense?
- Does the property I am going to buy lose its value over time?
- In how long do I have to finance this project?
- Is it a real need or a new fad?
By answering these questions, you will give up taking out new credit 99% of the time! Indeed, you will realize that you do not necessarily need the object that you wish to buy. Some life projects still require money: marriage, work, etc. However, by postponing the start date of the project, you have time to save money. For example, I got married almost 2 years after proposing to my wife, so that I could put money aside every month and thus not need to take out a loan.
Ditto for the works, you can start by doing only one room rather than a total renovation. Do it little by little! Everything high-tech should not be bought on credit, these are goods that lose value very quickly and quickly go out of fashion. I am thinking in particular of smartphones…
Here are the different steps to pay off your debts quickly:
- step 1: build up precautionary savings;
- step 2: calculate your budget, reduce your expenses to have a greater ability to repay and thus repay your debts more quickly;
- step 3: analyze your debt situation;
- step 4: use the snowball method to repay debts more quickly.
It’s your turn!