How Recurring Deposits Could Help in Reducing Debt

For many of us, debt can be a significant burden that weighs us down financially and emotionally. Whether it's credit card debt, a personal loan, or an outstanding mortgage, finding effective ways to paying down debt and regaining financial freedom is essential. One tool that can help in this journey is recurring deposits. In this article, we will explore how recurring deposits help in debt reduction. By understanding the benefits and mechanism of recurring deposits, you can take control of your finances and work towards a debt-free future.

Simple Strategies for Debt with Recurring Deposits

Let's examine some easy strategies to reduce debts with recurring deposits. 

1. Debt Snowball Method

The debt snowball method involves prioritising your debts from smallest to largest and paying them off in that order. With recurring deposits, you can allocate a portion of your monthly contribution towards the smallest debt, gradually reducing it over time. Once the smallest debt is paid off, you can roll over the amount previously allocated towards it onto the next debt, accelerating your debt reduction journey. 

Example

Let's say you have three debts - a credit card balance of ₹50,000, a personal loan of ₹1 lakh, and a car loan of ₹3 lakhs. You allocate ₹12,000 from your recurring deposit contribution towards the credit card balance every month. In just five months, you can completely clear your credit card debt!

2. Debt Avalanche Method

The debt avalanche method focuses on tackling debts with the highest interest rates first. By allocating a portion of your recurring deposit contribution towards the debt with the highest interest rate, you can minimise the overall interest paid and accelerate your debt reduction progress.

Example

Suppose you have two debts - a student loan with an interest rate of 10% and a car loan with an interest rate of 8%. By allocating ₹15,000 from your recurring deposit contribution towards the student loan every month, you can significantly reduce the interest paid over time 

The above examples are a clear indication of how recurring deposits help in debt reduction over a period of time. 

Tips on How to Use RD to Reduce Debt

Recurring deposits (RDs) can be a useful tool in debt reduction strategies by helping you save consistently and build up funds to pay off debts. Here's how:

1. Automate Savings for Debt Payments

   By setting up automatic monthly transfers from your checking account to an RD, you can make saving for debt payments a habit. The fixed monthly commitment encourages discipline and ensures funds are available when debt payments are due.

    

2. Earn Interest on Savings

   The interest earned on your recurring deposit balance can be used to make extra payments towards your debts. The compounding effect helps your savings grow faster over time.

    

3. Use RD as Collateral for Loans

   If you need to take out a loan to consolidate high-interest debts, you can use your RD balance as collateral. Many banks offer loans up to 90-95% of the RD amount at attractive interest rates.

    

4. Avoid Temptation to Spend

   Keeping your savings in a separate RD account makes it less tempting to spend the money on other things. The funds are locked in until maturity, helping you stay focused on your debt reduction goals.

    

5. Achieve Short-Term Savings Goals

   An RD is ideal for short-term savings goals like building an emergency fund or saving for a down payment. Once you've reached your savings target, you can use the maturity amount for paying down debt.

Tips for Using RDs Effectively:

• Assess Your Cash Flow: Ensure you have a stable cash flow to commit to regular RD payments without affecting your essential expenses.
• Choose the Right Tenure: Align the RD’s tenure with your debt repayment schedule to ensure the maturity amount is available when needed.
• Compare Interest Rates: Look for RDs with competitive interest rates to maximise returns.

While, recurring deposits help in debt reduction, combining them with other measures like budgeting, cutting unnecessary expenses, and exploring debt consolidation options can lead to a more comprehensive approach to managing and reducing debt.