Ways of dealing with debt

Theory and practice

When browsing articles online, you will find the same advice in most cases. Brilliant lists that start with consolidation loans and end with consumer bankruptcy. I have to disappoint you — this is very harmful nonsense that only preys on your situation, and I will tell you why I think so.

Most of this content consists of articles on financial websites that are polished for SEO (i.e., achieving the highest possible position in search engines). It just so happens that 99% of financial portals include links to consolidation loan offers within the content of such articles. Naturally, if you take out such a loan, they receive a commission for it. That is how affiliate marketing works.

You have probably connected the dots yourself and realized that such content is not created primarily for you and solving your problems, but for the profit of the portal owner. That is how it was, is, and will be. While this may be acceptable in many topics, when it comes to fighting debt, there is a clear conflict of interest here.

The second issue is the consolidation loan itself — its structure and the way it functions do not work in your favor. When you take one out, you turn many different obligations into one new one. This seems fine, as long as you don't think about it. You will usually get a slightly lower monthly installment, but a significantly higher total cost.

The fact that the full repayment amount of the loan increases does not require explanation. However, why is a lower installment bad?

• Debt broken down into lower installments is spread over a longer period, and consequently, you pay more interest every month.
• One lower installment gives your pocket a bit of breathing room, which may cause you to take out another loan.
• The installment has a set minimum level, which significantly limits your ability to fight debt using the most effective methods.

Repayment based on maximum cost-effectiveness

There are two main methods for dealing with debt. We will start with a purely mathematical approach that maximizes your efficiency in managing money. I assume you have a completed list of your debts, which you created based on the previous material. If not, go back to it and follow the instructions.

Using your list of obligations in a spreadsheet, sort the debts by annual interest rate. In the case of two debts with identical interest rates, their order is determined by the amount remaining to be paid.

Of course, simply arranging your obligations in a certain order changes nothing if you only pay them all according to the installment amount. The debt repayment method only works if you regularly overpay your installments according to the established order. Assuming the agreement does not provide for additional costs for early repayment, any amount is good — even just a few dozen zlotys.

The table above and all calculations are an example of how the order of repayment looks based on interest rates. Do not pay attention to the interest rates for specific products. In reality, they may differ significantly – this is merely a simplification.

Your minimum monthly cost is 1,300 PLN, but after paying bills and other essential living expenses, you only have 1,000 PLN left to cover your monthly installments. This means that soon one of your debts will not be paid on time, which will lead to unpleasant consequences.

You have several options in this situation:

• Pretend there is no problem. Rely on the popular saying "it will all work out somehow" and wait for payment reminders and new acquaintances from a debt collection agency.
• Use a payment holiday. If your cash loan allows for a suspension of payments, for example for 3 months at no extra cost, this is a temporary solution. Unfortunately, it does not eliminate the problem.
• Generate additional income. Work overtime, get a second job, tutor, etc.

In the case of an income deficit, only the latter option works. This is a serious situation, and to avoid falling into a debt spiral that will turn your life into a nightmare, you need to roll up your sleeves. Payment holidays are only a minor help, which you may not even have, depending on your contract.

Let's assume you manage to earn an extra 200 PLN per month, sell unused equipment for 400 PLN once, and pause your cash loan for 5 months. For the coming months, the required installments are 1,000 PLN (until the first debt is paid off), and you now have 1,200 PLN available after paying the minimum installments.

What does attacking the first debt on the list look like?

Amount remaining to be paid - minimum installment - one-time proceeds from the sale of equipment - additional cash at your disposal: 1,200 PLN - 200 PLN - 400 PLN - 200 PLN = 400 PLN

After the first month, only 400 PLN of the payday loan remains to be paid. You have nothing left to sell, but you still have the extra 200 PLN, so you pay off the payday loan in full the following month.

From now on, you have 1,200 PLN + 200 PLN (the amount of the payday loan installment) at your disposal, and the sum of your monthly installments is 800 PLN (including the payment holiday). This means you managed to overpay 1,200 PLN on your credit card, but the extra funds have dried up. After the cash loan deferral ends, you only have a surplus of 100 PLN — not bad, but not enough to make any real progress.

Getting rid of a high-interest payday loan is a good start, but the method has lost momentum, and you feel stuck again. Although the math suggests this is the best solution, emotions work differently.

The snowball method

The principle is very similar — we still attack debts in a specific order, but this time we change the sorting criteria. We pay off debts in order from the smallest to the largest, regardless of the interest rate.

Now the summary will look like this:

We are sticking to the previous assumptions: the total monthly payment is 1,300 PLN, you have 1,000 PLN available each month, but you earn an extra 200 PLN monthly, receive a one-time payment of 400 PLN, and take advantage of a 5-month payment holiday on your personal loan.

It sounds more complicated than it actually is.

What does the first month look like?

Remaining balance - minimum payment - one-time proceeds from selling equipment - extra cash available: 1,200 PLN - 200 PLN - 400 PLN - 200 PLN = 400 PLN

After the first month, only 400 PLN remains on the payday loan. You have nothing left to sell, but you still have that extra 200 PLN, so you pay off the rest of the payday loan the following month.

You still have 3 months of payment holidays left, and the 200 PLN freed up from the payday loan payment helps you pay down your overdraft. According to the calculations, by the fifth month (the last month of the payment holiday), you only have 100 PLN of debt left, leaving you with a 450 PLN surplus to put toward your third debt, which is the equipment installment plan.

Although the payment holiday ends in the sixth month, there is not much left of the third debt, and you have freed up much more than the extra 100 PLN from the first method.

On top of that, you can see the debts you have already conquered on your list, which gives you a boost of confidence and the belief that you will succeed with the rest as well. I believe you will!