Debt sculpting is a financial strategy used by individuals or businesses to manage their debts. The goal of debt sculpting is to reduce the total amount of debt owed and to pay off debt more efficiently. It involves restructuring debt by prioritizing the repayment of high-interest debt first while maintaining minimum payments on low-interest debt. This strategy allows the borrower to reduce the total amount of interest paid over time and pay off their debts faster.
There are several methods of debt sculpting, including the snowball method and the avalanche method. The snowball method involves paying off the smallest debt first, while the avalanche method involves paying off the debt with the highest interest rate first.
Debt sculpting is a common practice in project financial modeling. It means that the principal repayment obligations have been calculated to ensure that the principal and interest obligations are proportionate to the strength and pattern of cashflows in each period. To achieve a desired DSCR, the most common methods are to manually adjust the principal repayment in each period or to algebraically solve the principal repayment. See also cashflow matching, financial immunization, and asset-liability mismatch.
Debt sculpting can also involve negotiating with creditors to reduce interest rates or lower monthly payments. In some cases, consolidating debt into a single loan with a lower interest rate may also be an effective debt sculpting strategy.
Application
Debt sculpting is an effective debt structuring and project finance tool. Debt sculpting can be used to increase the amount of debt in a project. Traditional debt repayments are made in the same total amount each time a payment is made, with the principal portion increasing with each instalment and the interest portion decreasing as the debt balance decreases. This annuity (or credit foncier for the more affluent among us) payment method is common with home and car loans, where the same amount is deducted from your bank account every month.
Overall, debt sculpting is a useful strategy for managing debt and achieving financial goals. By prioritizing high-interest debt and making strategic payments, borrowers can reduce their total debt and pay it off more efficiently.
