It has been awhile since I had any articles in this series.
In last article, we discussed the realities of debt. I asked you to create an inventory of your existing debts and to share that with your family. In this article, we are going to discuss how to use that information and plan a workable attack strategy to overcome debt.
In 1914, Ernest Shackleton embarked on a journey to cross the Antarctic Continent. He secured a group of 28 adventurers and a ship with all the provisions they needed and headed south from Buenos Aires. Heading south into the Weddell Sea, they cut a channel in the ice for the ship. The work was slow going, and they eventually found themselves frozen in the Antarctic ice. From May through August, they found themselves frozen, waiting out the cold winter. Then on September 30, the pressure of the expanding ice became too great. Ice crushed their ship, leaving them abandoned on the ice. The crew made their way to Elephant Island, an uninhabited rocky island some 70 miles from their location. There was a shelter. For food, they hunted seals by using themselves as bait. Eventually they secured one of the lifeboats and floated it to South Georgia, some 800 miles north in the Atlantic. They were eventually rescued in June 1916. (Read the above link, there are so many awesome details to go over in this story).
The reason I regurgitated this story is to emphasize that when problems seem unsurmountable, persistence and patience can enable you to overcome obstacles. Have a positive attitude. Work with your friends and family to achieve your goals. Have faith, and exercise it. You can do it if you continue to work diligently.
Step One – Stop Incurring Debt
After you are injured, the first step is to stop the bleeding. Two simple steps will help you do this.
- Build an emergency fund.
- Quit using credit cards and consumer loans.
When you have a decent spending cushion, it will keep you from having to pay interest on debt. That, and it will reduce stress and conflict in your home. We have a credit card (we got one to build up credit for a house loan), but we pay it off completely every month in order to avoid paying interest.
Step Two – Pay Off Your Debts
If you do incur debt, work to pay off as quickly as you can. Using your budget, decide on how much extra you can afford to go towards your existing debts. Look at your inventory and decide which debt you should focus on first. You can choose one of two methods 1) Highest Interest First or, 2) Lowest Balance First. Each has its advantages.
If you focus on highest interest first, you will eliminate the most expensive debts first, and will pay the least amount of money over the time you are paying off debt. But it will take longer to reduce the number of creditors you have, and you will have delayed psychological gains (it will take longer until you can mark a debt as done).
If you focus on the lowest balance debts first, you will reduce the number of creditors more quickly, which means the number of minimum payments, and quicker psychological wins. However, you will end up spending more overall if you neglect the financial effects of the psychological gains (akin to home team advantage in sports). We are focusing on our student loan, looking to pay it off with tax returns in February, even though our mortgage has a higher interest rate.
Once you pay off one particular loan, roll that money over into the next loan to pay off. Create a debt paying off plan.
Example: Say I look at my budget and decide I can afford $250 extra per month. I have the following debts:
|Description||Balance||Interest Rate||Min. Monthly Payment|
|Credit Card #1||$5231.47||17.25%||$85.27|
|Credit Card #2||$10625.85||18.5%||$142.56|
I would probably start by focusing that $250 into credit card #1 (similar interest to credit card #2, but smaller debt). I would pay $250 + $85.27 or $335.27 to that account until you pay it off. Then I would roll that $335.27 into the next account, such as the car loan. That $335.27 + $225.54 = $560.81 to the car until paid off. Continue the process until all the money is concentrated into the mortgage. Dave Ramsey referred to this process as the “Debt Snowball”.
Create a spreadsheet, listing all your debts with the planned payments. Plan your spending, month by month and project out your interest, fees and balance. With your wife, play around with the numbers and discuss payoff strategies. Look at the amount you will save by paying debts early. Look at dollar amounts, look at savings and freedom you will gain. Decide on a tentative strategy. If things come up, you may need to adjust in the future, but come up with a workable strategy and stick to it as best you can.