You will be able to list your debts by cost and decide which to repay first.
Rank your debts by interest rate, highest first, and put any spare money on the debt at the top. That order saves you the most money, because each extra dollar goes to the debt that charges the most interest.
Most people choose a different way. Some pick the smallest balance for the satisfaction of crossing it off. Others pick the lender that sends the most reminders. Neither choice looks at what each debt costs you each year, and that cost is what ranking by rate is based on.
Hafiz is 31 (an example) and owes money in three places. He has S$3,000 on a credit card that he has rolled over since a holiday, S$6,000 left on a personal loan he took for his wedding, and S$18,000 on a car loan. After his payday transfers and his emergency fund, he has S$300 a month spare for debt. He keeps asking which debt to tackle first.
For each debt, write three figures: today's outstanding balance, the interest rate and the minimum monthly payment. A card statement shows all three for each card. For a loan, the statement or the lender's app shows the balance and the instalment, and the loan contract shows the rate.
For personal and car loans, use the effective rate. The effective interest rate is the yearly cost of a loan once the way you repay it is taken into account. Lenders often advertise a lower flat rate, which is calculated on the original amount for the whole term even though you are paying the balance down. Because it ignores the shrinking balance, a flat rate understates the real cost. Compare loans on the effective rate. If you can't find it in your contract, ask the lender.
Some debts are easy to forget. Check for instalment plans on a card, buy now pay later (BNPL) balances and money you owe to family. A family loan usually has a zero rate, and its minimum payment is whatever you agreed.
Leave off any card you pay in full by the due date every month. You owe that balance for a few weeks, but no interest is charged on it. The costly kind of card debt is a carried balance, which is a card balance kept from month to month.
Sort the list by interest rate with the highest at the top. Card balances and personal loans usually sit at the top, because the lender has nothing to take back if you stop paying and charges you for that risk. A home loan, which is secured on the property, and a study loan usually sit near the bottom.
Hafiz's list, sorted by rate, looks like this (the rates are invented for the example):
Credit card: S$3,000 at 25% a year, minimum payment S$90 Personal loan: S$6,000 at 9% a year effective, instalment S$280 Car loan: S$18,000 at 5% a year effective, instalment S$520
The rule has three parts. First, pay the minimum on every debt every month, so nothing falls into arrears or picks up late fees. Second, put every extra dollar on the debt at the top of the list. Third, once that debt is cleared, add its whole payment to the next debt down, and keep going until the list is done.
Hafiz pays S$90 + S$300 = S$390 a month on the card while the personal loan and car loan get their normal instalments. The card is cleared with the ninth payment, and the interest along the way is about S$305 (at the example rate). The S$390 then moves to the personal loan, so he pays S$280 + S$390 = S$670 a month on it. The car loan stays at its normal instalment of S$520.
On many cards, once you carry a balance, new purchases are charged interest from the day you make them, with no interest-free period. Your card's terms say whether your card works this way. If it does, use a debit card for daily spending until the balance is cleared. Until his card balance is gone, Hafiz pays for daily spending with his debit card.
Paying off a debt at a given rate is the same as earning that rate with no risk. Every S$1,000 that Hafiz pays off his card saves him about S$250 a year in interest at 25%. To match that by investing, the S$1,000 would need a return of 25% a year after fees, every year. Few investments promise a return close to a card's rate after fees, year after year, and none can guarantee it. The saving from the repayment is certain.
The comparison changes for cheap debt. S$1,000 off Hafiz's car loan saves about S$50 a year at 5%. Low-rate debts such as a car loan or a home loan don't have to be cleared before you invest, because the comparison with investing is much closer. Lessons 6.2 to 6.4 show where investing fits once the expensive debts are handled.
Darren, from the earlier lessons, has only a study loan, which he pays at S$250 a month by GIRO. His card has been paid in full automatically since lesson 2.4, so it stays off his list. He has no expensive debt to clear, so he keeps paying the study loan on schedule and moves on.
Ranking debts by interest rate and paying the highest rate first is sometimes called the avalanche method. Its main rival is clearing the smallest balance first for motivation. That approach costs more in interest, but it suits some people better. The two repayment methods, balance transfers, debt consolidation plans and how to talk to a lender when you can't pay are taught in the courses "Money Foundations: budget, debt, buffer" and "Credit and debt: scores, cards, loans and BNPL".
For this course you need only the list and the order. Gather your statements and loan apps now, because every debt you owe is about to go on one page with its rate beside it.
List all your debts in order of interest rate and mark the one you will pay down first.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).