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Are you in debt? You don’t have much time left

Slovaks apparently like living on debt. However, the era of cheap money is definitely over.

Ján Tonka | Personal finance | 25. August 2023

If you don't want to join the almost half a million Slovaks who have a bailiff on their hands, get your finances in order as quickly as possible.

Next summer, the European Central Bank will start gradually raising interest rates, which will also mean higher repayments for Slovaks. We have been very good at getting into debt in recent years. But we will soon see how our repayments will go. If you have contributed to the growth of debt in Slovakia, we have some good advice for you:

1. Audit your personal finances

First of all, audit your personal finances throughly. The audit should not only apply to joint stock companies and it should be done more often than once a year. Regular review of personal finances would definitely help a lot of households as well.

Make a list of all liabilities – whom and how much do you owe, the monthly payment and the reamining repayment period. You can also use our personal finance management app Finbot to get a better overview of your debts, assets and overall financial situation.

Don’t close your eyes to your problems. As with substance abuse, over-indebted people should, first and foremost, admit that they have a problem. At the end of the day, life on debt is a form of distorting the (financial) reality. Only once you know exactly what your financial situation is, can you start doing something about it.

2. Consolidation can save you thousands of Euros

If you have more than 2 loans, consider consolidation. Loan consolidation is the process of merging multiple loans into one. The goal is to reduce the total overpayment and often also the monthly instalment. This step alone can save you thousands of euros.  

It is indeed important who you owe moeny to – whether it’s a bank, a non-bank institution or, God forbid, a usurer. Mortgage and consumer bank loans have long been the cheapest types of loans. If you must owe someone money, let it raher be a bank.

If you have been repaying all your loans diligently in the last 5 years, you should have access to bank funding. Otherwise, you have a negative entry in the credit register and you can probably forget about any bank loan.

Let’s have a look at a simplified example: Mr. Indebted and his family live in an apartment he inherited from his parents. So he doesn’t have a mortgage. However, he has plenty of other debts – he borrowed 24,000 euros from a bank for a new car almost 2 years ago, he owes 3,000 euros on a permitted overdraft. In addition, they had recently a bit of fun with his wife and children and went on a long-planned summer vacation. However, they had no cash, so they paid by credit card. In total, these 2 weeks cost him 2,000 euros. His situation today is as follows:

Mr. Indebted still has 6 out of the original 8 years to go until his loan is disbursed, and still has to repay almost 20,000 euros. The arranged overdraft and debt on the credit card is relatively fresh and he has one or two years remaining until it is paid off. At the current level of instalments, Mr. Indebted will pay the bank 7566 euros more over the next 6 years than he initially borrowed.

Despite the unfavorable situation, the Indebted family still has several options to improve their financial situation relatively quickly. Since they own the apartment they live in without a mortgage, they can get a cheaper loan through a general-purpose mortgage with the real estate as a collateral, and pay off all three loans with the high interest rates. Such a loan can normally be obtained up to 70-80% of the value of the property at a maturity of 20-30 years (depending on the specific bank), interest rates are still around 4-5% per annum.

The second option is to refinance all three loans into a new (refinance) consumer loan with a lower interest rate. The result could look like this:

If they repaid all their debts with the general-purpose mortgage, they would save in total up to 3,992 euros on the interests. Even refinancing the existing 3 loans with a new consumer loan would save them 2,734 euros. Therefore, in both cases, it would be considered a significantly “profitable” (i.e. less loss-making) transaction.

However, it is possible to achieve the best results by the combination of loan mergers and their early repayment in extraordinary instalments. After merging the old loans into one, the new monthly payment would be lower by 348 or 330 euros than in the case of original loans, respectively. The Indebted family could use this money to repay the loan early and, effectively, further reduce the overall overpayment.

3. Early repayment

If you have already consolidated your loans, or you have to skip this step for some reason, it is time for an early repayment. The logic behind the early repayment is very simple – your return is equal to the interest you pay. The unpaid (saved) interests represent your net return – guaranteed and risk-free. If you are in the process of early repayment of a loan with a 15% interest rate, it’s like getting a 15% annual return on each extraordinary repayment.

Start investing today 

If you only have one loan that you want to repay early, it’s easy. If you have 2 or more, you need to decide which one will you start repaying first. Basically, you can choose one of the two approaches:

  • The snowball method – repayment of loans according to their amounts from the lowest to highest. This repayment method emphasizes the psychological side of things. If you start repaying your loans from the lowest, you will see progress relatively quickly. Small and frequent victories in the form of fully concluded loans will motivate you to forge on ahead. After the loan has been concluded, you will use all the funds that were made available (equal to the amount of monthly instalment of the concluded loan), for the extraordinary repayment of your second lowest loan. The more loans you repay completely, the faster you will repay your remaining debts.
  • Repayment based on the interest rate - simply rank all your loans according to the interest rate and start with the extra repayments for the loan with the highest interest rate. Its reapyment will be followed by the second most expensive loan etc., the same as in the previous example.

From a purely mathematical point of view, option 2 will alway be more advantageous, i.e. repaying loans from the most expensive to the cheapest. However, the risk of this approach lies in the fact, that you might not see real progress for a long time. If you, for example, save diligently for a half a year and repay a large loan early without any visible change, you can easily lose motivation and throw the entire concept of early repayment out the window.

Repaying smaller loans quickly, one after another, will bring small and more frequent psychological vicotories (wins). Those will in turn fill you with energy to persevere and eagerly throw yourself into the next loan in a row. Whatever approach you choose, it is important to be disciplined and persevere. If your situation today is the result of ten years of life in debt, it will probably take a while for you to get out of it.

So far, the economic situation in Slovakia and in the world is playing right into your hands. Unemployment is low, wages are on the rise and loans are still available/accessible. Well, as Warren Buffett says: “Only when the tide goes out do you discover who’s been swimming naked”. The good times will come to an end at some point, there will be fewer jobs, wage growth will slow down and loan instalments will also increase. If you want to put your personal finances in order, it’s about time to start.

Ján Tonka
Ján Tonka
Head of Finbot
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