Debt Layering Strategies: How to Sequence Repayments for Maximum Financial Efficiency

Having multiple debts and servicing them simultaneously has become common for modern consumers of financial services.  It can be a somewhat scary and overwhelming proposition, but it doesn’t have to be if the debtor approaches it responsibly.

It’s not enough to just pay off the debts, even though that’s the key thing to do.  It’s equally important to structure the debt repayment process carefully and to pay off the debts in the correct order.  The best sequence is the one that will incur the least interest.

What is Debt Layering?

Debt layering is a strategy that involves paying off debts in a specific order to maximise financial efficiency.  It’s, therefore, not the same as debt consolidation, where all the debts are turned into one and paid in instalments.  Instead, layering requires the debtor to pay all of the individual debts separately but in the proper order.

The factors considered when choosing which debts to pay first include interest rate, balance, loan terms, tax implications, and risk.  It’s therefore not important why the debt was incurred, but rather how costly it is to pay it off.

For instance, crypto debts can change in value based on the price of the crypto itself. When choosing which debt to pay, users should consider that the value of their crypto debt may fluctuate due to market volatility in crypto prices.

Step-by-Step Framework to Layer Debt Efficiently

In order to layer the debt payments in an efficient way, a debtor should take the following steps when analysing the state of their debt:

List and categorise your debts

The first step is to be aware of all the debts one has and to categorise them accordingly.  The list should include information about the loan type, outstanding balance, interest rate, monthly minimum payment, and loan terms.  It should also note if the loan is secured or not.

Know Your Budget and Surplus

On the other side of the planning efforts, debtors should be aware of their budget and how much they can afford to pay towards the loans each month.  Not all surplus should be allocated towards paying off the loan, as it’s essential to have a small safety net first – typically around 3 to 6 months of expenses.

Choose the Financial Priority

The debtor should also determine their financial priority.  Some choose to pay the least amount of interest, while others prioritise being debt-free as soon as possible.  Both options have merit, and it’s a personal decision.

Once the debtor has organised their debt in this manner, they should select the debt layering method that best suits them.

Popular Debt Layering Strategies Explained

 There are several popular debt layering strategies that most debtors typically choose from.  These differ based on the main goals of the strategy.

The Avalanche Method 

This strategy focuses on paying the high-interest debts first.  You continue to pay off all debts simultaneously by paying the monthly minimum on each one but also make extra payments towards the debt with the highest interest rate.

This method saves the most money, as the most expensive loans are paid off first, and it accelerates the total debt elimination over time.  It’s the method for those looking to save the most.

The Snowball Method

This method focuses on paying the debt with the smallest balance first, regardless of the interest rate.  After paying off the first and the smallest debt, you should move on to the next until you’ve paid them all off.  This also creates a sense of momentum.

It’s the easiest method to track, and it builds confidence that all debts will be paid off as the change in attitude is visible.  It’s the best option for those who need to see the change in their financial standing in order to move on.

Hybrid Method

A hybrid method presents a mix of the two in a way that the debtor chooses, in a way that is ordered and balanced.  It’s, therefore, best for specific cases that don’t fall neatly into any of the other scenarios we’ve mentioned.

Advanced Layering Tactics 

Once you’ve decided on the basic debt layer tactics, there are more complex ones that debtors should consider.  These factors include taxes, financial risks, and market conditions, which should be considered when deciding how to repay the debts.

Maximise Pension or Student Loan Trade-Offs 

In the UK, graduates who have paid off Plan 2 or Plan 4 student loans can legally reduce their monthly loan repayments by increasing their pension contributions. This is achieved through what is called a salary sacrifice scheme.

For instance, if you repay 9 percent on income above £27,295, earning £37,295 means paying £900 annually. Increasing pension contributions by £3,000, your reportable income drops, and therefore, the payment drops to £630 while your pension funds increase. 

Variable vs. Fixed Rate Loans

Some loans have fixed interest rates, and others have variable rates.  The contract usually specifies in great detail how and when the interest rate can change, and in most cases, it does grow whenever it’s allowed to.  This means that for a long-term loan, the debtor may end up paying significantly more than they initially agreed to when they first took on the loan.

The debtors should start with variable-rate loans, as they need to try to pay them off before the interest rates rise.

Risk-Based Prioritisation

Not all loans carry the same risk for the debtor.  For instance, a loan taken to purchase a car uses the car as security, meaning that the bank can repossess the car if you’re not making the payments on time.  Similar effects are accomplished with a mortgage on a property.

It’s best to start with riskier loans, such as those that have securities that could be put at risk if you don’t repay them on time.

Windfall Strategies

A windfall strategy refers to how a debtor would utilise a sudden influx of funds.  This could come from tax refunds, gifts, bonuses, or investments made by the debtors. For instance, using the best cloud mining platforms, can provide a passive income that you could collect regularly and put towards the debt. Cloud mining platforms enable users to mine coins and generate passive income without the need for expensive equipment. Users pay a subscription to use the service, which provides resources shared among the users. 

Since these aren’t planned, many debtors fail to put them towards paying off the debt.A safer strategy is to use the additional funds to pay off the loans with the highest interest rate first.

Debt Timing

It’s also important to factor in debt timing when planning your finances.  Many debts offer grace periods and zero interest periods.  Some also offer a flexible payment plan.  Debtors should consider these features and incorporate them into their payment strategy.  This doesn’t always mean using every offer that you’re provided with.

Conclusion

It’s essential to pay off debts on time and make the minimum monthly payments.  However, it’s equally important to have a debt layering strategy that will determine which loans are paid first and which are paid before they are due.

When creating such a strategy, a debtor should consider the loan size, payment speed, interest rate, and the associated risks.  The strategy could focus on the cost of the loan or on the speed with which it will be paid off.