How to optimise your loan repayment strategy
You'll probably take up at least a couple of loans in your lifetime, based on your needs and goals at any point in time. As there's a wide range of loans available out there in the market, such as personal loans, mortgage loans, renovation loans, student loans, car loans, credit card balance and personal lines of credit, it's a good idea to think about which loans you should fully repay first, and which can be paid off more gradually.
A good start in prioritising which loans to fully pay off is making sure you do your homework in comparing interest rates and outstanding tenors.
Essentially, there are 2 ways to manage your outstanding balances - you can either choose to pay down the facility with the highest interest rate first, or pay off the unsecured facility with the least outstanding balance first. It's important to remember, however, that these 2 methods are not applicable to structured loans, such as mortgage, car and renovation loans.
The debt avalanche method
Focusing your resources on paying off debt with the highest interest rate is called a debt avalanche. Using this strategy to shave off your debt will most likely see you paying off debt in a shorter time period and will also give you the highest amount of interest savings.
The debt snowball method
The other repayment option you could choose is the debt snowball method, where you pay off your debt starting with the lowest loan. This could help reduce the total number of outstanding loans you have, and the upfront, small wins at completely clearing a loan may help you feel less overwhelmed.
Which method makes more financial sense?
Let's say you have 4 loans to clear, each with a different effective interest rate (EIR) and outstanding balance1.
| Type of loan | Total outstanding loan balance |
|---|---|
| Credit card A (EIR 28% p.a.) | SGD2,000 |
| Credit card B (EIR 24% p.a.) | SGD12,500 |
| Line of credit (EIR 18% p.a.) | SGD1,000 |
| Balance transfer (EIR 4% p.a.) | SGD8,000 |
| Type of loan | Credit card A (EIR 28% p.a.) |
|---|---|
| Total outstanding loan balance | SGD2,000 |
| Type of loan | Credit card B (EIR 24% p.a.) |
| Total outstanding loan balance | SGD12,500 |
| Type of loan | Line of credit (EIR 18% p.a.) |
| Total outstanding loan balance | SGD1,000 |
| Type of loan | Balance transfer (EIR 4% p.a.) |
| Total outstanding loan balance | SGD8,000 |
If you use the debt avalanche method, that means you'd choose to pay off credit card A first, because it carries the highest EIR of 28% p.a. Even though credit card B has a higher outstanding balance of SGD12,500, it's got a lower EIR of 24% p.a., so you'd turn your attention toward repaying it fully after you've repaid the outstanding balance of credit card A.
If the debt snowball method's what you choose, you'd opt to pay off your line of credit first as it carries the lowest outstanding balance of SGD1,000. After you've cleared that loan, you'd then shift your priority toward fully repaying credit card A, followed by the balance transfer loan and finally credit card B.
Whichever method you choose, be sure you at least make the minimum required payments on your loan balance. If you're able to, try to pay off more than the minimum required payment in order to shorten your repayment period and lower the interest fees. For example, if your credit card only requires you to pay off 2% of your balance every month, simply paying that amount would prevent you from being charged late fees, but it's not really going to go toward paring down your outstanding bill if the interest rate levied on the card is EIR 20% p.a.
Ultimately, if you don't want to be saddled with mounting interest payments that can really add up substantially over time, it makes more financial sense to rely more on the debt avalanche method to pay off your loans.
Debt repayment tools
We've got some great debt repayment tools for you to manage your debt portfolio. You could actually take on a personal loan to clear your outstanding credit card balances, equivalent to up to 8x your monthly salary2, spread over a tenor of up to 7 years. Since personal loan interest rates range from EIR 7% p.a., this is a great option if you've got credit card debt carrying a significantly higher interest rate ranging from EIR 24% p.a. or more. Plus, you get the perks of a longer repayment period3.
Another tool you can pick if your total unsecured loans total more than 12x your income is debt consolidation, which combines your debt into just 1 loan4. HSBC's Debt Consolidation plan offers you the chance to refinance your outstanding loans into 1 term loan, for which you can make fixed monthly payments over a period of 1-10 years.
All in all, loans offer you a ticket to chase your dreams, whether it's buying a new home, getting that PhD in London, or opening your own cafe. If you manage your debt repayment plans optimally, you'll not only be able to reap benefits like interest savings; you'll also be able to pursue those dreams with much-needed peace of mind.
1 Chart is for illustration purposes.