Each week we ask a question to help you focus on an area of your finances that might need a closer look. This week: How can I get out of debt?
Most people carry some kind of debt. Whether it’s so called ‘good debt’ or ‘bad debt’, you’re still living on money that belongs to someone else. And they’re no-doubt charging you a premium to do so.
Get rid of your debt and you’ll get rid of paying interest. Interest is essentially spending your money to buy exactly nothing, so the day the interest repayments stop is a very good day indeed.
Is good debt worth paying down?
A quick rewind to talk about ‘good debt’. If you’ve got debt that’s reducing your taxable income or returning an investment that’s greater than the interest you pay on it, it might be worth holding onto it. So that might be a loan attached to an investment property, or a margin loan you took out for investing purposes.
Many advisers would also put your primary mortgage into the good debt category. That’s because your home is an appreciating asset that over time will hopefully be returning more than the interest you’re paying on the loan.
That said, who doesn’t want to pay their mortgage off as quickly as possible? After all, your home will still appreciate in value whether you owe money on it or not. If you can get rid of your mortgage, you can free up both the money you’re spending to repay the loan each month, plus you’ll free up considerably more home equity. If going back into debt is something you want to do.
Other types of good debt might be a student loan that has no or a very low interest rate. The interest you pay on the loan might also be tax deductible. So it’s worth talking to a financial adviser if you’re considering paying down your student debt.
All other debt has got to go
Your credit card or personal loan debt is a no brainer. Unless you use your car exclusively for work purposes, your car loan is on the hit list too. In fact, any other debt you are currently carrying that is attached to something that will fall in value, doesn’t earn you money and isn’t tax deductible is out the door.
Know exactly what you owe
First things first – tally up everything you owe. Yep, all on the one spreadsheet or notebook page – every cent.
Yes, it’s daunting to see the total amount of what you owe. But it is what it is.
How will you ever get a strategy together to get out of debt if you don’t know what your end-goal is?
Commit to making it a priority
There are a thousand things you could spend your money on. Thousands. But for now, you’re going to commit to spending your money on one thing only: the path to get out of debt.
Sure, you’re going to have to eat and do the myriad other costly things that make up a life, but not much. Cutting down on how much you spend is critical if you want to free up the funds you need to get out of the red.
Start saving here:
- 3 simple tips to stop overspending
- 101 frugal tips to help you live a richer life
- 15 simple ways to save stacks on your groceries
Pay as much as you possibly can
Just as there are plenty of ways to spend your money, fortunately there are plenty of ways to pay it back too. The number one thing to keep in mind is to never pay only the minimum balance owed. Always pay more – as much as you can.
To motivate you, consider this. If you have $2,000 owing on your credit card charging 16.97 per cent interest and you only make the 2 per cent minimum repayments each month, your debt will take you more than 8 years to repay and that $2,000 of credit will cost you around $1,315 in interest.
No way is that a good deal. No way is that going to be you.
Choose a debt repayment strategy
The first thing to consider is whether it’s worthwhile consolidating all your debts into one, hopefully lower-rate loan. This might mean adding to an existing loan that you have, or you might decide to refinance the lot into one new loan. There are pros and cons to this approach, which we go into in detail here:
You could also try the debt-snowballing method for an instant psychological boost. Basically, you list your debts in order of smallest to highest amount owed and then you pay the minimum on each debt and put anything extra towards the smallest debt first. You’ll soon find yourself with less creditors demanding money from you, and that can keep you motivated.
More on this method here:
The problem with the debt snowball is that while it’s a psychological boost, it’s not necessarily a monetary one. The most cost-effective way to pay off your debts is to pay the debt with the highest interest charge first. So, try listing your debts in order of highest interest rate to lowest, and tackle the one at the top of the list first.
That’s most likely going to be your credit card debt. For unfathomable reasons, interest rates on credit cards continue to be sky-high, even thought the official rate is way low and savings account rates are rock bottom.
Here’s how to tackle your credit card debt:
Then stick to it until it’s done
One of the biggest reasons that loans get on top of people is that they don’t make consistent repayments. Don’t be that person. Set up automatic repayments to come out of your account the day your pay hits your account. Or, maybe the day after, just to give it some leeway.
That way, your debt repayments will come out of your account before you can spend the money elsewhere.
Even better, if you spend well and find you’ve got money left in your bank account on pay day, move that across to your debts as well. Every dollar counts, so even if it’s only $10 or $20 more, it matters. Just remember the example above and know that every dollar you pay now is saving you from paying a lot more later.
Once you’ve got your system in place, be patient. Your debts are out of here, it’s just a matter of time.
I’ll leave you with more articles that will all help you get out of debt faster. Start today, make a plan, make your repayments, and start ticking your debts off your list. The sooner you can free up all your repayment cash, the sooner you can invest it to ensure you’ll never need credit again.
- 5 tips to get on top of your debt – and stay there
- It’s time to take control of your debts
- 6 steps to ditching the debt
Find the rest of our Money Focus series here.