At some point in life, most of us have accrued a debt or two. Don’t feel bad, but do take action to get rid of, and avoid bad debt in the future. Bad debt is the kind you get into buying a depreciating asset with money you don’t have – like a car loan or credit card debt. Good debt is an investment that has the potential to increase in value over time, like a home mortgage. For this article, let’s concentrate on the bad debt. Bad debt is very easy to acquire if the user is not conscientious of their spending habits. I encourage everyone to make sure their credit cards come from a bank with an app attached to it. That way you can instantly know how much you’ve spent by the day using the app to make sure you keep your credit card purchases to a level you can pay off monthly.
There are ways to pay down debt without allocating all of your free income to payments. Before making a decision on how to pay down your debt, my first recommendation is to create a spreadsheet with all the debt amounts, minimum payments, interest rates and how much (the actual dollar amount) you are paying in interest annually based on the amount of debt and interest rate. I think it’s KEY to see the actual dollar amounts you are spending on interest per year to better understand and motivate you to get rid of it soon. You know the saying, you can’t manage what you can’t measure. Being aware of the dollars spent on interest for bad debt is the first step to getting back on track.
Once you have a spreadsheet of the debt you own, there are two ways that work to pay down debt.
The first way: Pay off the debt with the highest interest rate first and then work down the line.
This is my favorite way – because it tackles the problem of high interest rates. I cringe every time I see someone paying abusively high interest rates charged by some credit card companies. Say NO to high interest rates by paying those off first. Don’t give credit card companies the satisfaction of taking your money like that.
Paying off the debt with the highest interest rate takes a lot of discipline and patience. The debt will grow faster and accumulate quickly because of the high amount of interest added to your bill every month. In order to pay this debt down faster, the payments must exceed the minimum required payment. If the minimum payment is $50, try to pay $75. This will speed up the process of paying down the debt.
The second way: Pay off the debt with the lowest balance and work up.
If you have several debt balances on multiple accounts; and you are having a hard time paying a large debt balance because you feel like you are going nowhere with small payments, then it might make sense to pay the lowest balance and work up. There is more gratification when debts are paid quickly and that keeps the motivation rolling to the end.
Both ways will create a snow ball effect, meaning that when one debt is paid in full, that monthly payment amount is applied to the next debt payment and so on. For example, if debt payment #1 is $100 a month, then once debt #1 is paid off, the $100 payment will instead be applied to debt payment #2 and so on until all debts are paid in full.
Once all debts are paid, there are more decisions to make.
If you feel that you can’t control your spending, put your credit cards in a drawer and use cash. Give yourself enough cash to make it through the week and replenish weekly. You will have the greatest sense of awareness and discipline with this routine. Only use credit cards in emergency situations. The key is to pay off credit card balances completely every month; this will help you to achieve the ultimate goal of increasing your credit score. If you don’t like using cash, call your credit card companies and tell them to lower your limit to a limit that you can afford to pay off monthly. That way if you are above your monthly limit, your credit card won’t approve the purchase and you will be forced to live within your means. In working with our clients, we supply technology that can help you stay within your limits by setting alerts and notifying you when you’ve exceeded the amounts budgeted for monthly expenses. For more information and help on budgeting and taking control of your finances, contact us directly. (link to contact us page)
When you have mastered paying down your debt, create a workable budget to keep you on a positive financial track moving forward. Once you’ve tackled your debt, you can begin on a track to wealth accumulation and financial independence. Financial independence is the road to discovering financial happiness.