The psychology of debt repayment

Aug 01, 2022

One of the biggest misconceptions about money is that it is all math. Nothing could be further than the truth. We each have our own relationship with money, and all relationships have an emotional aspect.

Let’s extend this to debt.

Debt is not only about math. In fact, you will keep hitting against a brick wall if you do not change your perspective.

Debt has an emotional charge. The word itself is emotionally charged and evokes anxiety or even guilt. Debt increases stress levels and anxiety. It also keeps you emotionally obligated to individuals whom you are financially indebted to.

Debt has a huge financial cost too. When you service your credit card debt of around 24% annualized, be extremely mindful of the fact that this debt costs you a lot more than you can ever earn elsewhere. Even if you are servicing a much cheaper loan – say 12% per annum, once you clear it there is an immediate return there

As you spend precious money servicing your loans, your savings take a massive hit. Crippling your ability to save is a huge roadblock to financial freedom. 

Get ready psychologically. 

  • Don’t live in denial.

Keeping it a secret will not help. Come clean to your immediate family or spouse or close friend. Talk to at least one person whom you trust. Not only does it help when you share the emotional load, but a discussion can also put things into perspective.

  • Own your mess.

Yes, you did use it to obtain certain assets or for frivolous spending or even emergencies. But now it is overwhelming. You may even be ashamed. Once you identify the emotion and name it, it becomes easier to deal with. You can now control the narrative and are ready to take the bulls by its horns.

  • Change the narrative.

If you believe that you are doomed and will never be able to get out of this mess, that is exactly what will happen. Once you become a victim of such a thought process, you will never have the motivation to get out of it. What you think will eventually become your reality. Reframe your thoughts and get singularly focused on getting out of debt.

  • Identify loopholes.

This will give you a sense of control. Are you an emotional spender? Do you order in food all the time? Are you hooked onto online shopping sites? Do you eat out a lot? Do you spend a lot of time in coffee shops? Identifying certain habits or behaviour patterns will help you curb spending, at least till you get your debt repaid. These small changes will build up momentum, give you a sense of assurance and combined with the strategies I mention later, will get you on a debt-free path.

  • Take inventory.

Make a list of everything you owe. Credit card debt, personal loan, education loan, vehicle loan, home loan, home improvement loan, loans from family or friends. In an excel sheet, list them in order of interest rate, and size (amount of outstanding). Once you stack your debt on both parameters, you will be in a position to decide which route to take. 

Repayment Strategies

The first think you need to do is identify cheaper debt. If the interest rate on your credit card is destroying you with rates between 36% and 42% per year, look for cheaper avenues. You could get a personal loan at a cheaper rate. With that money, clear your credit card debt and service the less-costlier loan. If you have a home loan, approach your bank for a top-up loan, which should be cheaper than the credit card debt. This way you lower the pressure on interest payments.

Identify assets you can sell. In a bull market, you could sell some equity. Or, if you have a fixed deposit, you could break it to clear your debt. However, selling assets must only be done taking into account your overall financial situation, and whether or not you have many dependents, and an Emergency Fund in place.

Having looked at the above, there are two repayment strategies. A caveat tough: In both the strategies, an exception to the list could be the home loan as it runs into decades and has a significant tax break associated with it.

  • Debt Avalanche Strategy
  • Focal point being the interest rate

This is when you pay off your debts in order from the highest interest rate to the lowest, regardless of balance. Say you have a credit card outstanding bill of Rs 40,000 at 24% per annum interest rate. But your personal loan is 18% per annum. This strategy would need you to pay off your credit card bill with priority as it has a higher cost.

  • Debt Snowball Strategy
  • Focal point being the size of the debt

This time, size of the debt is the issue, not the cost of it. If you have many loans, this is a good way to clear the clutter.

In both strategies, it does not imply paying off one loan to the exclusion of another. Make the minimum payment on each loan, while the extra money you have managed to save should be channelized into the one with the highest interest rate/ small debt (depending on which strategy you opted for). Once you clear that, you move on to the next, and the next, until you are debt free.

The right choice depends on your mental makeup.

Both strategies will help you get on track and build momentum. But the one you choose is completely dependent on your mental makeup.

Logically, it is better to pay off the highest-interest-rate debt first (Debt Avalanche). Get rid of the costliest debt because reducing the total amount of interest-paying liability would benefit the investor from the mathematical perspective when considering the total payment to clear the debt.

That makes sense financially and theoretically, but the psychological aspect can make or break the plan.

You may be desperate to get some feeling of control. In that case, paying off the smallest debt first will help you get that sense of achievement. Anyone who has ever tried to tackle a daunting task--whether cleaning up a house or tackling a large project at work--knows that there's great power in just taking those first small steps. The Snowball Strategy is kind of a behavioural trick, the idea being that taking small steps can lead to a sense of motivation and empowerment.

Nothing is written in stone. You can try a combination. If you are really saddled with debt, you can work at eliminating the smallest loan first to keep you motivated. After getting one or two out of the way, you can switch to tackling the most expensive debt. A word of caution here: Have a written plan that you adhere to. Or else you will be switching between the two constantly and not make much progress. Figuring out the right strategy is completely dependent on you and your mindset. You need to narrow down on what drives you.

In closing: If you are really overwhelmed and this advice does not help, then seek the services of a professional financial planner.

Related Reading:

More on Behavioural Finance

Articles by Investment Specialist Larissa Fernand

Add a Comment
Please login or register to post a comment.
© Copyright 2024 Morningstar, Inc. All rights reserved.
Terms of Use    Privacy Policy
© Copyright 2024 Morningstar, Inc. All rights reserved. Please read our Terms of Use above. This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.
As of December 1st, 2023, the ESG-related information, methodologies, tools, ratings, data and opinions contained or reflected herein are not directed to or intended for use or distribution to India-based clients or users and their distribution to Indian resident individuals or entities is not permitted, and Morningstar/Sustainalytics accepts no responsibility or liability whatsoever for the actions of third parties in this respect.
Company: Morningstar India Private Limited; Regd. Office: 9th floor, Platinum Technopark, Plot No. 17/18, Sector 30A, Vashi, Navi Mumbai – 400705, Maharashtra, India; CIN: U72300MH2004PTC245103; Telephone No.: +91-22-61217100; Fax No.: +91-22-61217200; Contact: Morningstar India Help Desk (e-mail: in case of queries or grievances.