Not all debt is bad. Utilizing debt and leverage as a means to buy more assets that have the opportunity to grow exponentially and well beyond the stated interest rate you are paying – is savvy and strategic. Many wealthy individuals understand this calculated risk and the opportunity it presents.
But on the other hand, debt can single handedly derail long term goals and financial lives if not managed appropriately and effectively.
My Rule of Thumb as it Relates to Debt is this…
- Use the credit card with the mindset that it is a debit card. In other words, everything you put on the credit card you could afford to pay in full today if you needed or wanted to. This will avoid your credit card balance ever getting to a level in which you cannot pay it off in full.
- The items that you do go into debt for, ensure that they have the opportunity to either increase in value over time or be necessities utilized by you for many years to come with a minimal interest rate. A home, a business, a car, an education to increase your skills, etc.
Going into debt for lifestyle or frivolous expenses essentially means that you cannot afford that lifestyle. That is the reality.
And on the other hand, everyone has a different set of circumstances and excuse my french, but shit happens. Unexpected home repairs, medical expenses or childcare costs, etc. Things come up that have a meaningful impact on your bottom line.
So if you find yourself in a position where you feel overwhelmed, uncomfortable or suffocated by debt – read below for a few ways to think about moving forward.
There are Three Core Strategies to Pay Down Debt
The real issue is the interest that is being paid. If you have multiple credit cards, student loans, a mortgage, etc. We are talking about hundreds or thousands of dollars being spent every year in interest. It will be very difficult to get ahead if you are paying the minimums on numerous lines of credit without a strategic game plan to pay the debt off.
Before moving onto the strategies, first and foremost, you need to organize your debt. List out your debt by amount, interest rate, monthly minimum, and payoff date. Then let’s get to work.
The Snowball Effect
The snowball method focuses on paying off your smallest debt first and creating a snowball effect as you continue to payoff larger balances over time. While always paying the minimums on all your debt, you focus on paying off your smallest debt first then roll the amount you had been paying on it into payments on the next largest debt.
Many people appreciate seeing progress, right? Check something off the list – you feel accomplished! If you start seeing one paid down in full, perhaps you will have the motivation needed to keep going on the next debt line and the next. The snowball effect.
The Avalanche Method
The avalanche method consists of focusing on interest rates. You determine which debt has the highest interest rate and focus solely on paying that down first while paying the minimums on all your other debt. This reduces the amount of interest you pay, which also frees up more cash to pay down other debt.
The avalanche method will save you the most in interest payments over time.
Debt consolidation consists of combining multiple debts into a single new one. When an individual has multiple credit cards or multiple lines of credit, it can be overwhelming to create a plan to pay off because you just aren’t sure where to start.
Debt consolidation is a great way to consolidate your debt for purposes of better organization, streamlined payoff and for the potential to reduce interest payments.
There are two main ways to accomplish this – a personal loan or a balance transfer on a credit card.
4 Ways to Best Prepare Yourself So You Don’t Have to Take on More Debt
There are some things we can control and other things we can’t. See below a list of four ways you can best prepare yourself against those unwanted and unexpected costly events:
- Have money saved up in an emergency fund with up to 3-6 months worth of monthly expenses saved and readily available for use if needed.
- Budget for miscellaneous or unexpected events – especially if you own a home or have children.
- Lower and negotiate your fixed expenses, if you can. Rent, utilities, insurance, etc.
- Create another stream of income or side hustle. Perhaps not something that you work on daily or that takes up too much time. But something on the back burner that you have that you can flip the switch on when needed in the event you need more income coming in for a specific purchase or emergency
Blog Post: Ditch the Debit Card
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