The Third Step to Financial Freedom: Paying off Debt
Updated: Apr 13, 2019
Hello Money Talkers! Today’s blog is all about tackling your debt. Becoming debt free is the third step to financial freedom.
If you don’t have any debt, then CONGRATULATIONS, you may skip step three and move on to step four!
Unfortunately, the average American household currently has a whopping $137,063 in debt, according to the Federal Reserve. Credit cards, student loans, mortgages, car loans, and personal loans are consuming people's lives. Debt has become the norm. “Oh, you can’t afford the designer shoes you want? Put it on your credit card!” “Oh, you can’t afford that vacation? Put it on your credit card!” We have been sold the American dream, but are living the American Fraud.
IF YOU CANNOT AFFORD TO BUY IT IN CASH THEN YOU CANNOT AFFORD TO BUY IT AT ALL! A lot of credit card companies try to lure you in with “one year free, no interest” or “spend $500 and get $100 credit” blah blah blah blah blah hooplah. If you are good with paying bills then this can be beneficial, for example, when I got my Lasik surgery I put it on my Chase Freedom card with 0% annual percentage rate (APR) for 15 months. That has worked out well for me because I had the money to pay it off in the allotted time, so I essentially financed myself with no interest. However, if you put something on your card that you cannot pay off within the allotted time, then you are signing yourself up for debt. This is because these companies hope that customers rack up a large balance and then do not pay it off in time so that they can charge hella interest. That is how credit card companies make money; they give people money that don’t have enough money and then charge them more money for borrowing that money! Beware!
Primarily, the debt problem is occurring because a lot of Americans are living beyond their means. What’s more insane, is that debt is not something that only occurs to poor people. Even wealthy people end up in debt. The more money they earn the more money they spend, this is called “lifestyle inflation”. Basically, regardless of social class, most Americans that are in debt keep digging themselves in deeper. Luckily, there is a light at the end of the tunnel.
The first step to getting out of debt is knowing what you owe.
In order to do this, gather your most recent statements for all loans and credit cards. You may also want to get your credit reports to verify all debts. Some debts reported may be fraudulent, and you may even be the victim of identity theft and not know it if you have never checked your credit reports before. You can check your credit reports for free at CreditKarma.com.
Now, make a list of all of your debts. You do not need to include your mortgage as this is considered “good debt” (if there is such a thing) and you might sacrifice other important goals to pay it off early. On this debt list, be sure to include the name of the creditor, interest rate, balance, and minimum monthly payment.
Now I know this sounds crazy, but you CAN try lowering your interest rates. One way to lower your interest rate is to call your credit card or loan issuers to see if you can get a lower fixed rate on the balance owed. If you have been making consistent payments on your card or loan for at least six months credit card companies seem more willing to offer lower rates when you ask. The worst they can do is say no… but they could also say yes! It is a possibility, but you won’t know until you try.
Negotiating for a lower interest rate not working? Another way to lower or even eliminate your interest rate is a balance transfer. A balance transfer is a way to move credit card debt from one credit card to another with the goal of saving money in interest. When you're paying high interest on a credit card, transferring that debt to a card with a lower interest rate can help you reduce the amount of interest you are charged as you pay it off. So how do you eliminate your interest rate all together? When searching for a balance transfer card you should use a credit card with a 0% introductory APR offer for balance transfers. Basically, a 0% introductory APR offer means that you won't have to pay interest on your purchases for a specific time period. So if you pay off your balance within that time period you forgo all the interest you would have had to pay on your previous high-interest card. To compare balance transfer cards, or any cards for that matter, you can go to bankrate.com. The experts at Bankrate examined over 300 credit cards to pick their favorite credit cards for 2019. Their list includes credit card advice and reviews so that you can find and apply for the right credit card for your situation.
One more tactic to get lower interest rates is debt consolidation. If you're drowning in debt, can't negotiate any lower interest rates, or if the math works out, a debt consolidation loan may be the right choice for you. Also, if you have extremely high-interest rates, high monthly payments, and too many bills to keep track of, a debt consolidation loan might help as well. Please be aware, that while this option sounds great it is not a smart decision for everyone. While consolidating your multiple loans into one loan with a lower interest rate wrapped in a little bow sounds like a gift, it might not be. Here are a couple of things to consider when evaluating if a debt consolidation loan is a good option for you.
Time: Figure out how long it would take you to pay all of your cards off at your current payment rate. Compare that to the length of the consolidation loan you're considering. Even at a lower interest rate, it may cost more over time than if you just paid your cards down faster.
Amount: Check what your monthly payment on a debt consolidation loan would be. If the loan payment is less than you pay to your cards now than you will probably be paying more in interest over time, since your loan term will probably be long.
Behavior: One of the biggest problems with debt consolidation loans is that they do nothing to change the behaviors that got you into debt in the first place. If you're using debt consolidation as an easy way out of debt, NEWSFLASH, there is no easy way out of debt! You have to put in the work and pay it off, simple as that. The last thing you want to do is get yourself into debt, take out a loan, pay off your cards, and then repeat.
If you do decide that a debt consolidation loan is a good option for you then you can compare them on Bankrate.com as well. However, while Bankrate does an awesome job of helping you compare you should always do your own research just to make sure that you are choosing the right one for you.
After you have tried to lower your interest rates put your debt list in order from the largest interest rate to the smallest. The reason I like to tackle debt from the highest interest rate to the lowest instead of the smallest balance to the largest (which is apparently a popular choice) is that you will come out ahead financially this way because you will be paying less in interest.
The next step is to start tackling your debt. I like to use the debt stacking method. As much of your surplus from your monthly cash flow as possible should be thrown at your debt with the highest interest rate, this is called your “target debt”, while you simply pay the minimum monthly payment on the rest. It might take some time to finally pay off your target debt, months or maybe even years, but it will be worth your patience.
This is where your debt stacking begins to take effect. Now, all the money you were throwing at your old target debt, you will now throw at the next debt with the highest interest rate; including the minimum payment that you were putting towards your old target debt. All whilst continuing to only pay the minimum monthly payment for your other debts. Then so on, and so forth, until all of your debts are paid off in full.
I know… I make it sound easy; so let me break it down down. If, for example, I had 3 debts:
A Macy’s credit card with a $1,200 balance, minimum monthly payment of $60 and an interest rate of 29%
A Wells Fargo Credit Card with a $1,400 balance, minimum monthly payment of $40 and an interest rate of 26%
And an Amazon credit card with an $800 balance, minimum monthly payment of $20 and an interest rate of 18%
To begin, I would pay the minimum monthly balance on the Wells Fargo and Amazon cards and put my whole surplus towards the Macy’s card since it has the highest interest rate. Once I have paid off the Macy’s card, then I would put the whole surplus plus the minimum monthly payment that I was previously paying on the Macy’s card towards the Wells Fargo card. Then, when I have paid off the Wells Fargo card I would put my surplus plus the minimum monthly payments from the Macy’s and Wells Fargo cards that are already paid off and at the Amazon card.
I am well aware that it will be a lot of hard work in real life. You will really have to stick to your budget and try to just hunker down and get it done. There’s no other way around it, and I refuse to sugar coat it. Most people never get out of debt because they lack discipline. Many choose to continue to live above their means, even if that means being eternally in debt. But I believe anybody can be strong-willed enough to finally break free. It may take a period of being uncomfortable, but it will be soooo worth it to no longer be a slave to debt.
Here is a bit of advice while paying off debt. Paying off debt can be a long and frustrating process. If you’re working more and trying to cut back on your expenses more, it can be even more stressful. To adapt to the huge changes your making in your life in order to pay off your debt you should try to improve your quality of life with fun, cheap or even free activities. Literally, you can just swap out your costly expenses for cheaper ones. So instead of going out eating and drinking, cook and drink at home. It’s sooooo much cheaper, and healthier for you. Not to mention you don’t have to risk drinking and driving. Instead of going out with your girls on Saturday nights, invite them over for a game night, totally free. Instead of getting your nails and toes done every two weeks, do them once a month at the salon and once a month have a mani-pedi party with some friends. Go to a free fair, or museum, or cheap matinee, Groupon the heck out of everything. You can google fun and free activities in your area. My point is this, just because you are cutting costs to pay off your debt does not mean that you need to cut out your social life and be a hermit, it just means that you need to get creative.
Once you are debt free, your surplus from your monthly cash flow will be larger. This is because your surplus now includes all of the minimum monthly payments you were paying towards your credit cards and loans. All the money that you were throwing at your debt is literally EXTRA money. You can do with that money as you please. In fact, I suggest you do treat yourself to something nice as a reward when you get there (nothing ridiculous that will get you back into debt though). Imagine the things you can do with all this extra money! You could save for a downpayment to finally buy a home, you could put that money into opening up your own business, or you could invest it and grow your wealth. The possibilities are truly limitless!
Follow these instructions and you will be one step closer to financial freedom!