Anyone who has existing debt obligations or is planning on taking out a personal loan can benefit from a good debt repayment plan. Knowing how to budget for personal loans positively impacts your ability to repay your debt, enjoy financial stability, and maintain a good credit score.
In this guide, we’ll look at the elements of a debt repayment plan for personal loans and how you can strategize for better loan management.
Understanding the importance of a debt repayment plan
The purpose of a debt repayment plan is to facilitate your debt repayment process and protect your financial interests. A good debt repayment plan comes with numerous benefits, such as the following.
Good planning can help you save money over the life of your personal loan. It can prevent you from needing to pay late fees, which can rack up into a significant amount if you are not careful. Interest also accumulates, and good budgeting and planning for debt repayment can help you minimize how much you pay your lender in interest.
Alleviate your financial stress
Debt can be a significant stressor that causes anxiety. A debt repayment plan can effectively provide you with a sense of structure and control over your finances.
Boost your credit score
Missing a single monthly installment for your debt repayment can lead to a noticeable credit score drop. A clear debt repayment plan helps you stay on track of your monthly installments so you can avoid hurting your credit score.
Avoid loan defaults
Defaulting on a loan has grave consequences for your credit score and financial security.
Enable long-term goals
Like with planning for other priorities in life, having a repayment plan makes you more likely to achieve long-term financial goals. With a plan and budget in mind, you will be able to enjoy more financial stability and better credit health. You can become debt-free more reliably and quickly thanks to a solid debt repayment plan.
Creating a realistic budget to support the repayment plan
An effective debt repayment plan aims to resolve your issues while also letting you create a budget. If your budget isn’t realistic, then it won’t be able to properly support your plan.
Here are the common characteristics of a realistic budget:
- The budget is based on accurate information
- It accounts for both fixed and variable expenses
- Supports your short-term and long-term objectives
When creating your budget, here are the factors you should take into account so that the budget reflects your finances and debt repayment needs accurately.
Your budget hinges greatly upon your current income. That is why at the start of creating any debt repayment plan, you should note down your total monthly income. This should include:
- Earnings from side gigs
- Rental income
- Any other income that you can expect to receive in a month
Your expenses and spending patterns
It’s essential to track your expenses on top of your monthly income when you’re devising a debt repayment plan. If you can figure out your spending patterns, your financial needs will become significantly more predictable, which in turn makes it easier to budget for your debt obligations.
Consider the unexpected
The best plans should always be dynamic and flexible to account for changes and unpredictable expenses. It’s important to realize that in the event of an emergency, you might need to alter your budget. Consider how an emergency might affect your financial situation, and plan accordingly.
Putting money into a separate emergency fund account is a good way of dealing with any unexpected expenses that might arise.
Identifying and prioritizing debts for repayment
An essential step of creating an effective debt repayment plan is to identify the different types of debt you have and prioritize them based on importance. Some debts are more urgent than others to deal with, especially ones that come with heavy consequences or high interest rates.
To identify your various debts, you might want to list them all down and categorize them by type and repayment terms. This way, you can clearly see your current debt obligations. Make sure that you prioritize the debts that have higher interest rates or are more likely to go into default.
Negotiating with creditors for better repayment terms
If you are struggling to meet your existing repayment agreement, it may be worth going into negotiations with your creditors to obtain better terms. This may mean changes such as a temporary debt pause or an extended tenure.
Using debt consolidation to simplify repayment
Taking out a debt consolidation loan can be a useful way for you to simplify your repayment process. This is especially helpful if you have numerous sources of debt that make your repayment complicated.
Debt consolidation allows you to combine different debts together into a new one. This can help you extend your loan tenure or reduce your overall APR.
Utilizing balance transfer credit cards to reduce interest rates
A balance transfer serves to move your existing balances to a new credit card with more favorable terms. This usually means that the new credit card has a lower interest rate (or a 0% interest rate for an introductory period). Credit card issuers often offer promotions with low introductory interest rates for those who are interested in transferring balances to the new card.
The main benefits of a balance transfer credit card include:
- Lower interest rate
- You can pay off your principal loan faster, which means you will have less owed money overall
- Your repayment becomes simplified as you consolidate your various credit card balances
Note that some disadvantages do come with balance transfers. Common ones you should keep in mind are:
- Balance transfer fees
- Potentially higher annual percentage rate (APR) after the introductory period is over
- The new total credit limit might not suffice for your needs
- Penalties and restrictions may make the credit card balance transfer not worth it
Considering debt settlement as an option for unsecured debts
A way you can deal with unsecured debt is to eliminate it via the process of debt settlement. Debt settlement involves negotiating with your lender to eliminate your outstanding balance in the form of paying a reduced payoff amount. If the lender agrees, you will give them a lump sum payment that is less than the total amount you would’ve otherwise owed to the lender.
Typically, this kind of debt settlement is only for unsecured debts that are not backed by collateral. Examples include:
- Credit card debts
- Personal loans
Note that many consider debt settlement a last resort. It serves to resolve your debt and help you avoid bankruptcy.
If you are sure that you can’t feasibly repay your debt due to difficult circumstances, it might be worth seeking a debt settlement with your lender because having a debt account be “settled” is better than if it is “in default” or “unpaid”. Settling a debt shows you are a relatively riskier borrower than the average borrower, but it doesn’t hurt your credit score as much as if you defaulted on the loan.
Lenders are not obligated to accept your debt settlement request regardless of how reputable or credible their company is. If they do end up agreeing to settle, the amount you need to pay is generally within the range of 10% to 50% of the original loan.
Sticking to the repayment plan and avoiding new debts
A risk to having any debt obligations is that it often becomes easier to fall into even more debt. Getting behind on payments can lead to extra interest and late fees you might need to pay. In addition, since you need to devote a significant amount of your money to repaying debt, your savings may be limited. This might result in you needing to seek out yet another personal loan in order to make ends meet.
Staying debt-free requires a firm commitment to your repayment plan. If you’re having trouble staying on track and keep spending excessively or taking on new loans, here are some strategies to consider:
1. Prioritize your debt as a necessity
Many borrowers think that because their loan tenure is long, they don’t need to pay off the loan with urgency. However, it’s advisable to view debt repayment as a necessary type of expense that needs to be prioritized. Cultivate a sense of importance around your debt installments so that you won’t lose sight of your repayment plan.
2. Automate your loan payments
Many lenders and banks allow you to set up automatic payments for loan installments. This way, your lender will be authorized to take money from your bank account every month to meet the monthly debt repayment requirements.
3. Refrain from taking on new loans
Unless the new loan is to consolidate debt, it’s often a good idea to avoid shopping for new loans. If you’re working toward repaying your existing debt, taking on a new personal loan could drastically complicate your financial situation and debt burden.
4. Ensure you have an emergency fund
An emergency fund is necessary in today’s unpredictable world. By saving up for an emergency fund over time, you will be more prepared for any unexpected expenses, such as medical bills or urgent house repairs. Since you have more savings on hand, you can potentially avoid needing to take on any new personal loans in case of an emergency.
A good rule of thumb for how much to save for emergency funds is you should have enough money to last 3 to 6 months in living expenses. Notably, this does not mean you save 3 to 6 months’ worth of income. Rather, the emergency fund should suffice to get you by for that amount of time in terms of living costs, food, and other necessities.
Seeking professional help from credit counselors or financial advisors
Professional financial assistance can be a valuable way for you to gain new insights. They are able to assess your situation and see it from a new perspective that is enhanced by their many years of experience.
Here are a couple of reasons why credit counselors can be beneficial to you.
- Professionals bring their expertise and experience to your situation
- They are more objective when assessing your information and needs
- They can tailor a debt repayment plan just for you
- They can plug any holes in your existing plan and ensure a realistic budget
- They provide you with additional resources
- You can improve your financial literacy and debt management techniques
- You will have emotional support from a professional who can help you stay on track
If you do decide to procure the services of a financial advisor or credit counselor, make sure that you have chosen someone who is reputable and certified. They can help you with your financial goals in the long run, not just with your debt repayment plan.
Ideally, you want to build a relationship of trust with your financial advisor so that you may be able to find them in the future in case you have other needs.
Celebrating milestones and progress in the debt repayment journey
Celebrating your debt repayment progress can be a wonderful way to alleviate stress. It feels good to reach meaningful milestones, such as:
Paying off a specific debt: If you have numerous debt obligations, it is a big deal when you pay of any particular one of them (especially if it is more pressing).
Debt reduction targets: A debt reduction target may be a specific dollar amount, such as $1000 paid off, or a percentage, such as 25% or 50%. As you reach certain milestones, make sure you take a moment to acknowledge how far you’ve come in your debt repayment journey.
Decreased debt-to-income ratio: Your debt-to-income (DTI) ratio expresses how much of your income goes toward paying off debt. If you have significantly lowered your debt-to-income ratio, this is certainly a time to give yourself a pat on the back. Since 43% is generally the highest DTI ratio you can have before lenders start rejecting your personal loan applications, if you lower your DTI below 43% for the first time, that is a good time to celebrate.
You receive the final debt payoff letter: When you’ve reached this last step of the debt repayment journey, congratulations! This payoff letter serves as confirmation from your lender that the loan no longer exists, as you have successfully repaid it.
Personal Loans Company Reviews
Recently Updated Articles