Here we are at session number Four, and we’re going to be talking about 5 steps to get out debt. Before we can think about putting in place our own financial plans and looking ahead to our own future, we have to make sure that we have as much money as possible to feather our own nest. That means not paying money out unnecessarily to someone else. We have to get out of debt. I'm going to give you 5 clear steps to help you get out of debt. I'll give you a track to run on, so all you need to do is to bring your laser-focus (See Session 2) and before too long, you can be debt-free
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Getting out of debt – Introduction
Debt is part of our culture. It is expected that most of us will carry some element of debt for most of our lives. I've no idea how often I have heard the phrase – “You'll always have a car payment” But who says? Do we really have to accept that debt is a part of life?
All of my clients – and I can't think of any exceptions – got where they are by staying out of debt. They may have borrowed to develop their businesses, but they were never loaded up with credit cards and personal loans.
Now they are sitting pretty – owning their own homes, money in the bank, financially free
Most of them come from the Baby Boomer generation – 1945 to 1964. When they were growing up and establishing their businesses, credit was hard to come by, so they learned to do without it. These days, Credit is easy to get, even though the financial crisis has reined things in a bit.
Remember in the introductory session I said I was given two credit cards, without asking for them when I was a student – crazy! I also remember having to write a letter to my bank manager asking for an extension to my student overdraft – now I suppose you just apply online – It's all too easy.
It IS possible to go through life without debt.
Need to clarify that I'm not talking about mortgage here. Most everyone needs a mortgage to buy a house. I'm talking about unsecured debt – credit cards, loans, overdrafts. It IS possible to live without these, but it is the most difficult route.
It takes discipline and effort. You'll need to go without things you want, Or at least wait to get them, unless you have the money to pay for them.
For this podcast, I'm going to assume that you have some of this debt, and that you want to get rid of it. I'm going to show you how to do that, and how to stay out of debt. But before I do. I need to say this:
If you are drowning in debt, struggling to make your minimum payments, and taking out more debt to make the payments on the debt you already have, you need to seek help.
The best organisation I have come across for this is Christians Against Poverty – www.capuk.org Don't be put off by the religious name – it is a Christian charity but they offer free debt counselling and work with you and with your creditors to get you out of debt. They're an excellent, well-respected organisation.
Everything you need to KNOW
So, before we get into the practical steps, let's cover the things you need to know about debt first:
1 – Most debt is bad, some is good
Generally, debt is bad because you are paying someone else money, for the privilege of owning something earlier than you might otherwise have done. You can buy that big-screen TV on your credit card and you can have it now, not in six months!
I love instant gratification. Amazon Prime is the best thing ever! ‘Free' next-day delivery. But sometimes, even that aint enough for me! I have been known to pay a bit more for something by walking down the road to Currys, instead of ordering online and saving a few pounds – that's about as bad as paying lots of interest in order to have it now.
Paying money to someone else just to satisfy our need for instant gratification is madness. This kind of debt is bad.
The obvious exception to this is your mortgage. Few people can buy a house without one, and generally property increases in value over time.
This is a good measure as to whether debt is good or bad – is the thing you're buying going to increase in value? If not, pay cash.
It makes no sense to borrow money to buy a car which will be worth a quarter of what you paid for it by the time you finish paying for it! for an example of this, see video episode 245: How to buy a car debt free.
A possible other example of ‘good' debt is student debt – you could argue that you are borrowing to increase your future earning capacity?
You'll need to take a view – and if you must borrow, get the lowest rate you can (common sense)
I heard a great example recently, which might help you think about what debt is good and bad: What if I need a car to get to work and further my career, but need to borrow? Is that good debt or bad debt?
I'd argue that this is probably good debt, as long as it is the cheapest viable car you can find and the lowest interest rate debt. I wouldn't use this as an excuse to buy a nice car and get in hock for five years.
2 – Debt is not a tool, debt brings risk
I have heard plenty of people, financial experts even, say that you should borrow to increase your wealth. This is called leveraging.
For example, you could borrow money to increase your rental property portfolio. This makes sense given property increases in value, right?
- If you have no tenant, the mortgage still needs to be paid.
- If mortgage rates rise and the rent isn't sufficient to cover the payments…
- If the value of the property does drop, or you can't sell them when you need to
- What if you lose your job and can't service your debt?
- Or become ill and can't pay?
All these are risks, and debt increases risk.
The sad fact is, most people don't handle debt well. People have good intentions about paying off debt, but then never get round to it. Instead, they end up with consolidation loans and then max out their cards again.
Instead we need to know our limits, and not introduce the risk of debt getting out of control.
3 – Debt makes others rich, and keeps you poor
This should make you mad! As long as you are paying other people to fund your lifestyle, they're the ones getting rich, not you!
Take a cue from the Forbes 400 – The 400 richest people in America as compiled by Forbes magazine. In a recent study: 300 of top 400 richest people in America said that best way to become and stay wealthy was to stay out of debt.
But ask yourself, do you need the smart new car, or will a four-year-old motor for one quarter the price do for now? Again, see video episode 245 about how to buy a car without getting into debt.
We need to learn to hate paying money to other people, and instead pay ourselves first – see Podcast Session 3
So, three things you need to know:
- Most debt is bad, some is good
- Debt is not a tool; debt brings risk
- Debt makes others rich, and keeps you poor
Everything you need to DO
So let's deal now with everything you need to DO. Here are five steps to nailing your debt once and for all.
I must give credit for these to Dave Ramsey, whose book The Total Money Makeover I highly recommend. [Amazon affiliate link]
I'm also going to assume that you're up-to-date with your debts, and not falling behind. If you are behind on your payments, you need to get up to date before embarking on the steps to follow.
1 – Decide how much of your monthly budget you're going to set aside to pay off debt
Obviously, this should be as much as is humanly possible – we're not playing with debt here; we're trying to nail it!
Find every spare pound that you can in your budget. It won't hurt not to eat out at all this month, or for the next year if needs be. Sit down with your partner and push this hard – max it out.
Consider drastic measures: Could one or both of you take a second job? Can you sell some unwanted stuff to release more money?
2 – Use that money to build a starter emergency fund first
Wait, I thought we were paying off debt?
If you're in debt, you likely don't have any savings behind you. This leaves you exposed to things going wrong.
If you have no emergency fund, what happens if your washing machine breaks down? How do you pay for it to be fixed or buy another one?
Yup – credit card. That's no way to get out of debt!
So before we begin paying down our debt, we use our ‘pay-off-debt' budget line to first build up a savings fund of £1,000. That way, when small emergencies strike, you have the money to sort them out.
While you're doing this, make minimum payments on your debts. Keep them ticking over while you get this fund in place. Once it is in place, agree between you that this won't be touched if at all possible.
Good rules: won't be touched unless:
- You sleep on it first
- You both agree
3 – List your debts in order of outstanding amount – smallest first
Why this way? Why not in interest rate order? Shouldn't we pay off the most expensive ones first – highest interest rate?
We're after some quick wins; we want to see progress as quickly as possible. The feeling of paying something off quickly outweighs the small financial penalty of waiting to pay off a higher-interest loan.
An obvious exception to this is pay-day loans. These are very high interest – very high – short-term loans. If you're taking these out, you are on the brink of financial disaster. If you have any of these, you need to clear them as soon as possible.
4 – Blast that smallest debt with as much money as possible – make minimum payments on the rest
Piling as much money as possible against the smallest debt should see it paid off quickly. Of course, it depends how much it is; it might still take a year or more. But you will get a great feeling when paying off that first outstanding debt.
Once you have paid it off – close the account!
SIDE NOTE: If you have to dip into your emergency fund, temporarily stop paying off your debt and top up the emergency fund again as quickly as possible
Making minimum payments on the rest of your debts may mean they grow a little, but again, the quick win is worth it. And the next step will more than make up for the small extra interest you may incur while making minimum payments
5 – Snowball!
Once the first debt is paid off, take all the money you were paying off that, and pile it against the next smallest debt. This is added to the minimum payment you were already making, so you pay it off even quicker!
Then when this is paid off, take all the money you were paying against this, and pay it off the next credit card.
It'll be more money each time, until by the end of it, you're piling your whole monthly debt-reduction budget against the last outstanding debt. This rolling-up of the payments is why Ramsey calls it the snowball.
Once you get into this process and see the progress you're making, you'll get excited. You'll try to find even more money each month to throw against the debt to get rid of it even quicker. You may even contemplate selling your children!
These five steps are the best way I have come across to blitz your debt. They work because they tap into the human psyche and those quick wins really help you stay on track.
It may still be a long process if you have lots of debt, but Ramsey says most people can clear their debt within three years using this technique.
Can you stay laser focussed for that long? Are you prepared to make sacrifices to get rid of your debt once and for all? Are you prepared to say no to family and friends when they ask you out for a meal that isn't in your budget?
The best thing about this whole process is that by the end of it, you'll be used to paying yourself first. What do you do with the money you've been using every month to pay off debt?
Save it, that's what! And that's the topic for the next session: How to start saving
I hope that this session was helpful. Did I miss anything? Do you have any tips or tricks that work for you? Do you have any stories about your own efforts to pay down debt?
Do you have any questions?
Please leave any comments or questions at meaningfulmoney.tv/session4
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Again, next time we'll be talking about How to start saving. If you have any questions about this, go to meaningfulmoney.tv/feedback and leave a voicemail.
Thanks for listening – I'll talk to you next time