If becoming debt-free sounds like an impossible goal to you, then perhaps paying down debt is much more doable.
The trendiest financial resolution for 2016 is paying down debt. If becoming debt-free sounds like an impossible goal to you, then perhaps paying down debt is much more doable.
When I decided to start a business a few years ago, I was nearly resigned to the idea that debt was just a part of life. But, as I started learning more about business, entrepreneurship, and personal finance, I realized that there are many strategies to improve your financial position.
There are a few different ways to tackle your debt, but first, you have to get everybody in your household working towards the same financial goal.
Happy Wife (+ Happy Finances) = Happy Life
In relationships where financial obligations are shared, one partner is usually the spender, while the other is the saver. However, some tradeoffs have to be made.
In my family, we use the Rule of $100, meaning if an item costs more than $100, you have to wait a minimum of one month to purchase it. After 4 years of marriage, I think my harping about financial health is finally starting to sink in.
One night, as I was overcooking a cheap yet healthy version of stir-fry beef, the conversation turned to the family’s loan obligations. Since graduating pharmacy school, I have viewed my school loans with vehement distaste and have been complaining about them since the first day of repayment. We also have a mortgage and a property loan.
Seemingly out of nowhere, my husband asked, “Do you realize that we are paying almost $9 per day of interest on our property loan?”
I wish you could have seen the look on my face as I struggled not to say, “Of course I know that. I have been preaching about it for the last 4 years!”
Instead, I put on my “pharmacist face” (score one for retail pharmacy experience) and calmly said, “Yes, that is very frustrating. So, what are we going to do about it?”
That moment was a huge breakthrough, and it really got us motivated to work together to pay down our debt.
I have previously written about treating your personal finances like a business. Good personal financial health helps you lay the foundation for good business financial health.
Here are 3 strategies to pay down debt fast:
1. Pay down the debt with the highest interest rate first.
This method disregards balances and focuses on saving the most money solely based on interest rate. It works well if your balances and loan terms (the length of time required to repay) are all relatively similar, but it is not as effective when comparing the amount of interest owed on loans of differing term length and a much larger balance.
If you have an interest rate above 10%, as is common for credit card debt, then this is the strategy for you.
Example: a $140,000 mortgage at 4.4% for 30 years vs. $40,000 in credit card debt at 12.4% for 10 years.
In this example, you would pay an additional $184,800 in interest on top of the $140,000 mortgage for a grand total of $324,800. On the credit card, you would pay an additional $49,600 in interest on top of the $40,000 for a grand total of $89,600.
If these figures come as a shock to you, I encourage you to write down your loan terms and interest rates.
2. Apply the debt snowball method.
Made popular by financial guru Dave Ramsey, this method is a practical yet somewhat more psychological strategy.
The debt snowball method is basically choosing the debt with the lowest total balance and focusing all your extra money on paying it down first while only paying minimum balances on the others. Then, once the smallest sum is paid off, you take the amount of money you were paying towards the first debt and add it to the payment for the debt with the second-lowest balance.
This method disregards interest rates, loan term, and type of debt. It is a great method for the unmotivated debt owner because it uses small “wins” to develop good financial habits.
Example: Debt A is $14,000 and the minimum payment is $340/month. Debt B is $26,000 and the minimum payment is $400/month.
Let’s say you have an extra $500/month that you want to commit to paying down your debt. Using the debt snowball method, you would apply that extra money to the $340/month minimum payment and pay $840/month on Debt A.
As soon as you pay off Debt A, you then apply the $840/month immediately to Debt B. So, your payment towards Debt B becomes the original $400/month minimum payment plus the extra $840/month for a total monthly payment of $1240/month.
This strategy is a great motivator to get you started on becoming a good steward of your money. It is also a great strategy if your debt feels overwhelming and you don’t know where to begin.
3. Free up cash by using the lowest cash flow index ratio.
Using this method, you would divide your total payoff balance by your minimum monthly payment. The first time I ever heard this, I thought, “That makes a ton of sense for an entrepreneur!”
Using this method, the lower the number, the faster you should pay off the debt. A ratio <50 means poor cash flow, 50-100 is the caution zone, and >100 is most efficient in terms of cash flow.
Many businesses use this method to free up cash. The idea behind it is to free up cash in order to invest in other opportunities—not accumulate more debt!
Regardless of whether you choose one or a combination of all 3 of these strategies, it is important to have a financial plan in place. At the very least, do some of these quick interest calculations so you can see exactly how much you are spending on interest each day, month, and year.
It is a good idea to schedule time for an open family conversation about your financial goals. It may take you 4 years to get through to your partner, but it is your financial freedom at risk.
In order to live a happy, balanced life and have the freedom to reach for your entrepreneurial dreams, you must come from a financially stable place.
If you need help putting a financial plan together to save more money, or you want help with finding ways to make more money, contact me at email@example.com and schedule a free consulting call.