So we started the theme of savings by talking about a plan to spend. As you build a plan to spend, debt will be a part of your plan as long as you\’re in debt, of course. Now, 80% of the population has some form of debt, which means I\’m speaking to 8 out of 10 of you. With that, you want to make a plan to pay down and pay off that debt aggressively.
I meet so many people who live paycheck to paycheck, even though they may have incomes that don\’t justify that.
When thinking of those people, you might always think of the single mom with the four kids who is living paycheck to paycheck, but I beg to differ. I bet that there are so many more people than you would believe who live paycheck to paycheck. Oftentimes, this is because people aren\’t building margin into their personal finances.
Frequently in low-interest-bearing environments, people justify their purchases and what can happen is that they don\’t look at the stress and risk that comes with that. They assume that everything\’s going to be as it is now, and they forget to factor in the stress in the back of their minds that will weigh them down from all those payments. Although you may afford that car payment or that house payment, it doesn\’t mean that you can afford that item.
I have said this before, but it\’s essential to let it sink in that you need to first look at your finances from the standpoint of if you actually can afford this item or if it\’s just looking like you can afford it.
So today, I want to focus on three methods of paying down debt.
Method #1: Debt Stacking Method
The first method comes down to the debt stacking method. This method is also called the debt avalanche method. This method focuses on the highest interest first––paying off those items that carry the highest interest rates first. For example, in the unsecured environment that we\’ve been looking at in this theme in the last month, the one that would immediately come to mind would be––of course––the payday loan. This is the highest interest-bearing account that you can have. Now, the debt stacking approach, also known as the debt avalanche approach, would wipe out that type of debt first and would go step-by-step to pay down and off your debt, based on the interest rate alone.
Method #2: Debt Snowball Method
The second method comes down to the debt snowball method. This method focuses on the lowest balance, not the highest interest. So, you would end up paying off those lowest balances first to give you some level of momentum going into the preceding debts accordingly. With this method, once you pay off the lowest one, you take the difference of what you would have been paying on that previous debt and apply that onto the second debt to pick up steam, to have that snowball grow.
Method #3: Debt Margin Method
The third method I want to propose today is the debt margin method. Now, this method builds in options to your personal finances and what it does is take low interest-bearing alternatives and combine the debt into those.
For example, I previously brought up the example of a vehicle that you may have equity in. A vehicle is a secured loan, meaning you can take that vehicle and take the loan to the value amount that you can get out of it. Of course, you want to be mindful since it\’s a depreciating asset, and you want to ensure that you are not taking out more than the market value for that vehicle. Nevertheless, you take out that difference between what you owe and what it is worth, and you take that amount and put it directly to your highest interest-bearing account. If you have a payday loan, a line of credit, or a credit card cash advance of some kind, you take that money, and you put it directly towards those debts.
Once you have a combined loan, you are basically going to ensure that you don\’t have any other debts. If you do, you are going to focus on knocking out those debts one at a time based on their interest rate. Then, you\’ll come back and take that difference of each of those loans and put it towards that larger combined loan to get that paid off aggressively.
12-Step Process
So each method will have you organize your debt based on interest rate differently. Therefore, I broke it down into a 12-step process when looking at how the debt margin method works and how you would then structure the pay down and pay off of your highest interest to your lowest interest related items. These steps help ensure that you\’re constantly feeling and experiencing that progress because you\’re not paying so much to the interest but instead paying as much as possible to the actual principal you owe.
Step 1
The first step would come down to paying off any payday loans, anything with an absurdly high-interest rate (it\’s certainly high APR). Focus on this one first because it can typically be somewhere in the triple-digit range when it comes to an interest rate.
Step 2
The second step comes down to paying off your credit card cash advance loan. Often, these can have a 20% or higher APR attached to them. You want to pay this off as soon as possible since it\’s affecting your utilization and probably negatively affecting your credit rating and credit score. You want to be mindful of paying that down below 30%.
Step 3
The third step comes down to paying off your credit cards. These payments typically have a 15-18% annual percentage rate attached to them, and that\’s why it\’s important for you to prioritize these and get these paid off.
Step 4
The fourth step is paying off your line of credit. Oftentimes, these have a 12% or even higher percentage rate attached to them. It is crucial for you to make it a priority to pay this off next.
Step 5
The fifth step is paying off personal loans or signature loans. These loans often have an interest rate of 10% or more.
Step 6
The sixth step is paying off any recreational vehicles. These, in particular, have fluctuating interest rates based on what you qualified for, but they are typically about 6%.
Step 7
The seventh step comes down to paying off your vehicle loans. These typically have an interest rate of 2-3%, and unless you are utilizing your equity to pay off one of the higher items above this line item, you should focus on paying this loan off.
Step 8
Step eight comes down to paying off your student loans. Typically, these loans have an interest rate of 2-5% in today\’s environment. Now, you may have aged student loans that have a higher percentage than that, but you\’ll want to be mindful of getting these paid off, being that you cannot bankrupt them. These loans are not able to be removed if they are federally backed.
Step 9
Step nine comes down to paying off your HELOC, home equity line of credit, or home equity loan. These typically have a percentage rate of about 4%. You\’ll want to pay this off because this actually is secured by your home, and you\’ll want to be mindful of this being the next step before you attack your home loan itself.
Step 10
Step 10 comes down to paying off your primary residence (paying off your home loan). These loans right now are hovering between 3-4%.
Step 11
Step 11 comes down to rental properties. If you don\’t have a rental property, a secondary residence, or a second home, you can disregard this step. This step goes down to paying off that home equity line of credit or that home equity loan you may have. Now, this typically has an interest rate of 5-6%.
Step 12
Step 12 comes down to paying off your secondary or rental property home loan. You may have a family heirloom property that you have a loan on, a vacation property, or a rental property. This loan is the one you want to pay off next since the interest rate will typically be somewhere in the 4-5% range.
I didn\’t go into the business-related debt because that is outside your personal sphere per se. I want to focus first on your personal finances––the finances that you have for your household. Then, you can move on to your business finances and approach that with a payoff plan that works for that. So each of these methods have pros and cons associated with them, but it\’s important for you to look at which method works best for you in order to feel that momentum and progress. You don\’t want to just slump into trying to find an instant solution––an instant gratification approach to your debt––because often, there is not a quick fix to getting out of debt. It\’s easy to get into debt, but it\’s not necessarily easy to get out of debt.
There are so many detractors from you building margin into your life.
From having a certain lifestyle creep as your income has grown, to having influence or pressure from marketing campaigns, to family, friends, or neighbors, you need to look at this from the standpoint of playing the long game and not being short-sighted. Look at where you want your finances to be and focus on that vision.
That\’s why these three methods are here to help you in your journey to paying off debt.
