The debt-free system: Part 3: The good, the bad and the ugly truth!
(A tale about killing off debt…for good!)
So you’ve decided that you want to live a debt-free life, a life without the additional stress of you (and possibly your partner too) of having to work all the hours that God sent us just to cover the bills, some of which are more unnecessary than others, and to pay for the stuff that, whilst still filling up precious space in your home, no longer deliver the satisfying glow with which it arrived.
Not only have you decided that it’s time to pay off your debt, you’ve also begun to balance the books, instead of adding to the debt pile like an over eager member of the US Congress, you’ve started winning the war against debt. You may have even noticed some changes already, the bank statements, which once brought you nothing but dread when they arrived through the letterbox at the end of every month, now actually bring a smile to your face because you can see from the decreasing figures that a little bit further on in this journey you’re going to be completely free of the pressures of debt.
You may of heard about debt being split into one of two camps; Good debt and bad debt. Good debt being either debt (a mortgage) connected to the purchase of your house or an investment in yourself, usually in the form of a college/university loan. It earns its ‘Good’ tag by generally accruing a comparably low rate of interest and being used to ‘purchase’ goods that are considered by the majority as a valuable asset/wise investment. Bad debt on the other hand is the complete opposite, accruing high to extortionate rates of interest and used predominantly to purchase assets with little future value such as a car, a holiday abroad or a home improvement. Whilst I generally agree with the two distinctions, it would be a fool who would take on an unnecessarily high mortgage (or expensive education), for a house which is far too big for their needs, based on the understanding that it’s o.k because it’s only ‘good debt’. Even ‘good’ debt accumulates interest and requires repaying, and the price to pay is usually in the form of additional hours of work, stress and the loss of precious leisure time.
It is more than just a funny coincidence that those who have debts have a habit of underestimating the true scale of their debts. So now is the perfect moment to take a huge sharp intake of breath and total it all up….warts and all. Whether your preference is a fully-featured spreadsheet or a scribble on the back of an envelope, once you know where you stand then there’s only place to go….onwards and upwards.
Now you’ve balanced the books, realised the true extent of your debts it’s time to prioritise which debts to start wiping out first. At this point you may feel like getting a few easy kills, paying off multiple low-level debts just to clear out half of the list of debts on your spreadsheet, but taking shortcuts has never been the debtfreeminimalist approach and now is definitely not the time to start taking them. Irrelevant of their individual balance, once you know what you can afford each month (the excess of your incomes in relation to your outgoings), you need to take a look at the rates of interest charged on each of your debts (add this to the back of your envelope as well) and focus on paying the highest of these off first, irrelevant of the time it might take to do so.
Debt by priority is by far the most effective way to clear debts although you may come across the counter argument that this is not as psychologically motivational as the balance approach which focuses on wiping out debts with the lowest balances. My advice is at the end of the month to ignore the list of creditors, it really doesn’t matter who you owe money to, and to simply take a look at your total balance of debt each month because there is no greater motivator than seeing those figures tumble by more and more each month.
Prioritising debt is as crucial stage of debt reduction as any other, getting it right here could save you thousands of pounds in additional interest charges and months of debt repayments. Take the example of a £10,000 debt, 70% of which is made up of credit card/store card debts (25% typical APR) and 30% home improvement/car loan, which you can afford to service with £300 each month. If, just for the sake of a morale-boosting quick wipeout, you decide to focus on paying off the smaller, but less expensive (with regards to the interest it attracts), loan then yes you would pay off one of the two debts in less than 12 months in contrast to a 30 month wait taking the debt-free minimalist approach (highest APR first) but the total interest charges using the balance first approach are a staggering £2,531 MORE, meaning your £300 p.m payments need to continue for an additional 8 ½ months to pay off the exact same two debts. Convinced yet? You should be!
The debt-free minimalist approach: By; not taking on excessive amounts of ‘good debt’ (and needless to say no additional bad debt), facing up to the exact amount of debt which you’re in and then paying down debt by prioritising highest interest rate charges, you’ll have the most precise, effective plan with which to become pay off credit. Simply put, there is no quicker or better way of becoming debt-free, so that you can start to live the life of freedom which we all deserve!
If you’ve got multiple debts then click on the snowball calculator link below. Experiment for yourself the difference costs of prioritising your loans by either balance or interest, enter all the details of each debt and it will even give you a plan of action for wiping out debt in the most cost-effective way. http://www.whatsthecost.com/snowball.aspx