Choosing the right loan repayment strategy
Your nature and effective loan repayment
It’s easy to think that there is by far one best strategy for getting rid of debt – one that works for everyone. There are so many people striving for debt in the world, as well as a huge number of economists studying debt repayment, so by now a certain perfect solution has certainly been invented, right?
Debt repayment is reminiscent of diet and exercise – what works best for you is 100% individual. You need to find a strategy that suits your nature. That’s when the easiest way to start and stay with a personal payment plan.
Think about what you are like as a human being. What motivates you? What bothers you? Do you lose your patience easily? Do you find it difficult to focus on an individual project for long? Once you are aware of who you are, it will be much easier for you to choose the strategy that best suits your repayment plans.
Motivation to repay the loan
Motivation is your most important tool in your quest for debt relief. Without a solid and lasting motivation, giving up an entire repayment project is easy. This tendency is easy to explain by the bittersweet decisions you have to make when repaying debt.
Remember, the absolute best service you can do for your finances is to get rid of debt as quickly as possible. This is especially true for people with unsecured debt, whether it’s a credit card debt or an unsecured loan. In these cases, a significant portion of the total cost of the loan is interest expense. The longer the repayment period, the higher this amount.
If you want to speed up debt repayment, you have to pay your creditors more than what they demand of you. In practice, this means that you have to set aside extra money each month to pay off a debt that requires discipline and motivation. Therefore, you need to choose a strategy that maintains your motivation until you achieve financial freedom.
Choose a strategy that really works
If you use the keywords ‘payment plan’ or ‘debt relief’ online, a huge number of suggestions and strategies will open up. Some of these are great and really help. Others are less useful to your repayment process.
When you are consciously trying to get rid of debt, it is important to use a strategy payment plan that really works. We are now talking about methods that have been tested and proven to be useful for those striving for economic freedom.
One of these methods is called ‘Maximum monthly installment to be paid first’. It is a strategy that structures your loan so that it helps you pay off your debt faster than planned. In this guide, we’ll look at how the method works and how to use it to build a repayment plan. In addition, we look at the pros and cons of the strategy.
The highest monthly installment to be paid as a repayment strategy
The highest monthly installment to be paid in a nutshell
When paying off debt, it is always advisable to deal with debt accounts one at a time. The idea of a repayment strategy is to speed up this process. By doing this, you will reduce the cost of your loans. The highest monthly payment first is one of the methods of arranging your debt according to your monthly costs.
Using this strategy, you arrange your loan to the bank in order of monthly installments. In other words, interest or costs don’t matter – you focus on repaying the loans to the actual budget. Here is an example of a loan arrangement:
Mortgage loan: EUR 150,000
Loan period: 25 years
Loan interest rate: 3.10%
Monthly payment 715 EUR
Credit card: EUR 1,500
Loan period: 3 years
Loan interest rate: 24.4%
Monthly payment 57 EUR
Personal loan: EUR 4,500
Loan period: 4 years
Loan interest rate: 18.4%
Monthly payment 129 EUR
With the highest monthly payment first method, you start by focusing on a mortgage, then moving on to credit card debt and finally a personal loan. It is likely that you would have gotten rid of the unsecured loan accounts before paying off the mortgage.
Highest monthly installment compared to other repayment strategies
The highest monthly installment first differs from other repayment strategies in our loan calculator, especially in that it does not generally guarantee the first repayment of the most expensive debt. From a purely economic point of view, therefore, this may not be the best possible method. However, there are situations where a strategy can be helpful depending on what your debt looks like and what your nature is.
In the snowball and avalanche methods, as well as the maximum monthly interest rate first payment strategy, you usually pay off the unsecured loans first. This is because these are usually the smallest debt accounts compared to, say, a mortgage. In addition, these are the most expensive debt accounts, at least in the short term, when you compare the amount of the loan to the interest rates.
However, it is important to be aware of the total cost of interest in the long run. Mortgages are expensive debts no matter how you look at it. You usually pay several thousand euros in interest expenses over the decades when you pay off the loan. From a long-term financial perspective, focusing on this debt first may make sense.
Unsecured loan and maximum monthly installment
Unsecured debt is expensive because it has high interest rates. Personal loans or other unsecured loans usually have an interest rate of 10-30%. Most credit cards have an interest rate of 20-30% of the outstanding debt. While interest rate is clearly an important factor in the total cost of a loan, the amount and duration of the loan is also important.
Let’s say you have $ 1,500 in credit card debt. It is likely that your monthly budget has some capacity to repay this debt. It is also assumed that your credit card has an interest rate of 26.8% on the remaining amount of debt and that you have decided to pay off the debt account within three years. The equation looks like this
Credit card
Loan amount: EUR 1,500
Monthly payment 59 EUR
Total cost: EUR 2,119
This shows that the monthly payments payable are quite small despite the high interest rate. Nor are the total costs so high, at least when they are spread over 36 months (€ 17 / month).
Suppose that in addition to a credit card loan, you also pay a personal loan for 30,000 euros. Its interest rate is 15.06% and the remaining loan period is 8 years:
Personal loan
Loan amount: EUR 30,000
Monthly payment 492 EUR
Total cost: EUR 53 137
With a longer loan period and a higher loan amount, the total cost increases proportionately. In this case, you pay 76% of your loan amount as interest expense. With the highest monthly payment method, you first start with your personal loan, which costs less than $ 500 a month. After that, you switch to credit card debt.
When you only pay on unsecured loans, the highest monthly payment is a useful strategy first, as it will help you get rid of the biggest items of expenditure. The repayment plan also does not last for many years. But what happens when you combine unsecured debt with secured loans?
Secured loans and maximum monthly installment payable first
Today’s loan market focuses on interest rates on both secured and unsecured loans. In this discussion, both the loan amount and the loan term are easily forgotten. Yet the loan term combined with the interest rate relative to the loan amount are factors in the equation that make up the total cost.
Although mortgages have really low interest rates today, the size of these loans is considerable and the loan period is long. The above examples are still used. The total cost of the loan looks like this:
EUR 619 credit card debt (26.8% interest)
EUR 2,314 personal loan (15.06% interest)
The interest rate on a mortgage is very low compared to these loans. Currently, the average interest rate is between (insert correct amount)% and (insert correct amount)%, i.e., only a fraction of the interest on unsecured loans. However, a long-term loan is still the most expensive. Here is an example:
Loan amount: EUR 200,000
Loan interest rate: 2.66%
Loan period: 30 years
Monthly payment 804 EUR
Total cost: EUR 289 456
In the long run, then, a mortgage is the most expensive; this is the loan with the highest total cost. Of course, you need to consider the cost associated with the loan amount. In this sense, a secured loan is always better than an unsecured loan, but a mortgage still has the highest borrowing costs.
The highest total costs in the long run are at the center of everything when implementing the strategy of the highest monthly installment to be paid. When paying off the three debt accounts we mentioned here, you would start with a mortgage (804 EUR / month), then pay off a personal loan (492 EUR / month) and finally a credit card debt (59 EUR / month). This makes sense in terms of budgeting, but it is also a laborious way to pay off debts.
For whom is the highest monthly installment best suited?
When you pay off debt with or without collateral, you need to be aware of the consequences of choosing the highest monthly installment as your first repayment strategy. There is a high probability that the focus of your entire repayment process will focus on one loan – a large mortgage. This means you need to be sure that you are able to maintain your motivation even if you are working on the largest and heaviest debt account.
In most other payment strategies, the focus is the opposite. Because research has shown that people need a lot of motivation, especially in the early stages of a repayment plan, a strategy that focuses first on the smallest debt accounts is most commonly used. Alternatively, you can also pay off the loan with the highest interest rate, but as we’ve already noticed, it’s usually also the smallest debt account.
By choosing the highest monthly payment installment as your payment strategy first, most debtors will focus primarily on their mortgage. As we have already said, this is a good idea from a long-term economic point of view. However, the strategy only works for people who are sure of their motivation, despite the fact that the largest debt account is due first.
Motivation is your best friend when trying to speed up debt repayment. Many find it exhausting to start with a large loan at the beginning of a payment plan. In this case, it is more useful to resort to a different strategy. However, if you want to make your debt cheaper in the long run and don’t let the long repayment period interfere, the highest monthly payment you pay first may then be the best choice.
Highest monthly payment to be paid first: Benefits
Your daily finances will improve
However, when you choose to pay the highest monthly installment first as your payment strategy, long-term savings are not your main goal. The idea is that getting rid of the most expensive monthly installments first will also greatly improve your daily finances. Imagine how the elimination of several hundred euro monthly items of expenditure affects everyday life. This amount of money can be used for nice things – or alternatively to save.
You will reduce the total cost of the loan in the long run
Although mortgage interest rates are low, a large loan amount and a long loan term lead to the highest total costs. In a typical mortgage, you pay several thousand euros in interest costs. However, if you decide to set aside more money to repay your mortgage on a monthly basis, you will significantly reduce your borrowing costs. If we use the example above and compare it to the five-year installment, you can see that it has a significant impact on overall costs.
Loan period 30 years
Loan amount: EUR 200,000
Loan interest rate: 2.66%
Loan period: 30 years
Monthly payment 804 EUR
Total cost: EUR 289 456
Loan period 25 years
Loan amount: EUR 200,000
Loan interest rate: 2.67%
Loan period: 25 years
Monthly payment 911 EUR
Total cost: EUR 273 269
Your monthly payment would therefore have increased by approximately $ 110. Your total savings amount to EUR 16,200 or 18% of the original interest cost of the loan.
Unsecured debt accounts ‘disappear’
When you focus on a significant debt like a mortgage, smaller unsecured debts seem somehow more insignificant. You will pay this debt in any case in monthly installments that the loan company will charge you. You will likely get these debt accounts paid before you have completed your mortgage payment. You may get some peace of mind during your repayment that you know you will make your debt more affordable in the long run.
Highest monthly payment to be paid first: Disadvantages
Paying off the largest loan first is challenging
By far the biggest difficulty in first choosing the highest monthly installment to pay as your payment strategy is related to how your loan account is organized. The drive towards economic freedom is in itself difficult. For many debtors, starting repayment from the largest debt accounts seems like a hopeless task. You won’t save money if you abandon your payment plan before it’s even started.
Expensive, unsecured loans will not get rid of faster
Although the total amount of credit cards and unsecured loans is less than that of a mortgage, it cannot be denied that these are expensive loans. Compared to the amount of the loan, the interest rates are staggering. When you choose the highest monthly installment to pay for your repayment strategy first, you won’t get rid of the unsecured debt any earlier. By focusing on paying off your mortgage first, you may also be paying too little attention to unsecured loans.
Your repayment plan will probably last for decades
In practice, your payment plan will simply be your current plan with your bank, which you can supplement with additional payments each month if possible. If you pay off a mortgage, you already know that it will be several decades. Maintaining your motivation for such a long period of time is no easy task. On the other hand, all strategies inevitably involve a long repayment period when they include an insured mortgage.
The strategy of the highest monthly installment is suitable for those who want to save money and create a better financial situation in their daily lives in the long run. Use our debt calculator to create a payment plan and start your journey to financial freedom today.
