10 Common Questions about Debt

The average US household debt is over $135,000 according to a recent study by Nerdwallet, in the UK it is just under £60,000. Those are huge amounts yet most of us see having debt as a “normal” part of life and might not even think twice about the implications of all these loans.

In this second article in the “10 Common Questions…” series we’ll have a closer look at debt, the advantage of becoming debt-free, different ways to pay off your debt and how to stay out of debt long term.

1: Why is paying off debt so important? 

Becoming debt free has many different advantages. One of the main ones being that it will save you a LOT of money. Debts are hugely expensive, much more so than most people realize. By becoming debt-free you are no longer wasting money on a loan for something you might have purchased months or indeed years ago. 

Another key reason to become debt free is to no longer be indebted to anybody else and take complete control over your money. Whether you have a loan from your bank, a store or the government, when you’re debt free, nobody but you can make a claim on your money.

If you do ever need to take out a loan, such as for a big purchase like a house, you’re also much more likely to get a loan and with better conditions. The more responsible you show you can be with money (i.e. not have lots of outstanding debts), the more likely you will be able to pay back your mortgage, the less of a risk you are to a bank, meaning they are more likely to grant you the mortgage and at a lower interest rate. 

2: But doesn’t everybody have debt? Is’t that just part of life?

Having debt has certainly become the default for most people and indeed for society as a whole. We see having debt as a standard thing in life, but that of course doesn’t mean that it’s actually the BEST option to pursue. Having debt costs money, ties you to your creditors and might keep you in a job you don’t enjoy simply because you need to pay all those creditors. 

Added to that, if you are looking to progress and get ahead or indeed pursue Financial Independence, you don’t want to do “what everybody else is doing”. If you want to achieve different results, you need to do different things to what other people do. How many people do you know who have debt? And how many of those are Financially Independent? I think that says enough. 

3: But my interest rate is only 1.5%. Surely that’s not so bad? 

A trick that many credit providers use is to state their interest in monthly percentages, when really you should be looking at the yearly percentage. A 1.5% interest rate means the annual interest rate is 18%. That sounds a lot more serious, doesn’t it? 

Let’s look at a quick example of what 18% means in terms of the total costs for you. 

If you had a $1,000 credit card loan at a 1.5% monthly rate and an agreed payment plan of 3% per month (meaning each month you pay back 3% of the outstanding balance you owe) and a minimum of $10, you would pay back the incredible amount of $1,779 in total on this loan! Not only that, in addition to the nearly $800 in interest you pay, it would also take you 9 years and 10 months to pay off this loan. That’s a huge amount of time for a loan of $1,000 at “just” 1.5%. 

4: But what about that new car / planned holiday / latest gadget I want?

Living with debt and therefore buying something before paying for it, has almost become a standard way of life: something many of us don’t even think about anymore and take for granted. But it doesn’t need to be like this. A much healthier, cheaper and satisfying way to purchase something new is by being able to pay for it up front instead of by financing it.

In order to do this, you’ll need to set up savings goals and plan ahead about when you might need to make a bigger purchase, such as that new phone, your holiday or replace your car. Once you’ve got a goal you can work backwards and decide on a set amount you need to put aside each month in order to be able to have the money saved up at the time you expect you might need the money to make the purchase.

Becoming debt free doesn’t mean you can’t get that new gadget, it just means you save up the money first before you purchase it and just requires a little bit of planning (and patience!). 

5: How long will it take to pay off my debt?

Of course this depends completely on how much debt you have and how much you are able to free up to pay towards this debt each month. There are many excellent online debt calculators available that can quickly show you just how long exactly it will take you to pay off each one of your debts. Let’s have a quick look at an example to show you how fast it might go though. 

Let’s use the same loan from earlier as an example ($1,000 loan, 18% interest rate, 3% monthly payback with a minimum of $10). If you were able to pay an extra $25 each month in addition to what you get charged by default by your credit card company, you would “only” pay $221 in interest, over $550 less than the original $779! Added to that, with the extra $25 a month you pay, it would take you just 31 months to pay off the loan (a little over 2.5 years) instead of the 118 months mentioned earlier!

As each loan and situation is so different, I recommend you use an online calculator to play around with some different numbers of how much you might be able to pay off extra each month and see what the effects of this are on the total costs of your loans. If you have more than one debt it’s important to choose the right strategy for you when it comes to paying off your loans: using either the snowball or the avalanche technique.

6: What’s this “snowball” technique?

The snowball debt repayment technique recognizes that paying off debt isn’t just a numbers game where all you do is consistently paying some money towards your debt. There is a substantial psychological component involved in this process too, more specifically: motivation.

Your motivation to get started on paying off your debt, your motivation to keep going even when the journey becomes dull or hard and the motivation to stick with the adjustments you need to make to your spending habits. 

The snowball technique encourages you to start with the smallest debt that you have, and begin to pay down this debt as fast as you can. In the mean time you keep making the minimum contributions to any other debts you have, you don’t want to accumulate more interest or penalties than needed after all.

By beginning with the smallest debt you will pay this off relatively fast, giving you a quick motivation boost as you witness the results. Then you move on to the next smallest debt for which you now pay off the minimum amount you were already paying + the money freed up from the first debt. Each time you pay off a debt, you free up more money to start paying off your next debt.

7: What about the “avalanche” technique?

The avalanche technique is similar to the snowball debt payment technique with one difference: instead of starting with your smallest debt, you begin paying off the debt with the highest interest rate. This is after all the one that, when left over time, accrues the highest amount of interest on it, meaning that by paying this one off first you save yourself a lot of money over time.

Like in the snowball technique, make sure to continue to make the minimum contributions to any other debts you have whilst you pay off your highest interest one, to avoid extra charges.

8: How can I stay out of debt?

There are three key things you can do to avoid going into debt again. The first one is to ask yourself whether you really need what you’re buying right now at this price. Is there a cheaper option available that would do? Can your old phone last another 6 months? Can you wait for a newer version to come out and buy the discounted older version? 

The second habit to develop is to set up savings goals and plans: if you know you’ll need a new phone in the next few months, then start saving up for this today by consistently setting aside money until you have the money available. 

Thirdly, accept that sometimes life throws a curve ball at us that can lead to instant costs you just have to pay in the moment: a broken washing machine, a car maintenance or a vet bill that you just need to get done in the moment. For these emergency situations, make sure you have an emergency fund available: start building up $1,000 set aside that you only use for these emergencies. 

9: Paying off debt… then what?

Once you get rid of all debt, and have put in place measures to avoid going into debt again in the future, that’s a huge achievement in itself and most definitely is something to be proud of. But it is only one of the pillars on your road to Financial Independence. There are other steps you can take, in the area of your income, investing, retirement that you can now focus on towards a secure financial future.

Commit to moving on to the next area of your finances and continue your journey towards Financial Independence. (One way to do this is of course to make sure you follow this series of articles!).

10: Where do I start?

The road to becoming debt-free isn’t easy but certainly worth it, so if you are committed to paying off all your loans, here’s what you can do:

  1. Find out all you can about your current debts: outstanding amounts, yearly interest rates and monthly payback amounts.
  2. Start by paying off extra money towards 1 debt using the debt snowball or avalanche technique. Free up extra money from a yard sale, a side hustle or by picking up extra hours at work. 
  3. Make sure to stick to your minimum payments on all other loans, don’t default on those monthly payments.
  4. Once you’ve paid off one debt, use all the money you’ve freed up from no longer needing to pay off that debt to start on your next loan. Keep at it until you’ve paid off your last debt.
  5. Start building up an emergency fund to avoid having to go in debt in the future.

This article is part of the “10 Common Question series”, where I address issues about some key financial areas, including Financial Independence, paying off debt, increasing your income, retirement provisions, saving, investing, financial protection and much more. If you want to find out more about Financial Independence, you can sign up to my newsletter to stay up to date or get a free sample of my book 100 Steps to Financial Independence. 

Photo by Republica from Pixabay


10 Common Questions about Financial Independence

10 Common Questions about Financial Independence

Personal finance is hot. One need only have a look at the number of books, podcasts and websites dedicated to this topic to see that we have a keen interest in learning or perfecting our money skills. And that’s not so surprising: who wouldn’t want to have some extra cash, a more secure financial future and a more satisfying financial life?

Luckily, personal finance doesn’t have to be complicated. Whether you want to achieve financial independence or simply learn how to better manage your money, in this new series of “10 common questions…” you will learn all the essentials about personal finance and money issues.

In this first article, we’ll start off with the concept of Financial Independence (FI)- what it is, why you might want to pursue it and how you can achieve FI.

1. What is FI?

FI stands for Financial Independence, which can mean one of the following three things, depending on who you’re speaking to:

  • In the past, Financial Independence was often used to describe women who were financially independent of their husbands: they made their own money and didn’t need to rely on getting an allowance from their husbands.
  • Financial Independence can also refer to the process of growing up and becoming an adult and no longer needing to rely on your parents for money and / or financial help or advice.
  • Lastly, Financial Independence can mean you generate enough passive income that you gain independence from your job and essentially no longer need to work for money.

In this article I will mainly focus on that last meaning of Financial Independence: removing the need to work in your life and being able to pay for your expenses through passive income streams.

2. What is passive income?

There are 3 different types of income: active income, passive income and semi-passive income.

An active income is money you generate by selling your time for money: most of us with a job get paid for showing up to work every day and working on specific during during the time we spend at work.

Then there is passive income: money you get by doing nearly nothing. Think about the interest you receive on your savings account.

A semi passive income is income that you don’t need to work for every day, but does now and again require some work: a landlord receiving rent from its tenants or a musician who sells records 24/7 in any country without physically being there.

3. Why would I want to achieve FI?

One of the main reasons you might want to pursue FI is to free up time and be able to fill your life with more of the things you love doing: be that spending time with your (grand)children, hiking with your pets, pursuing a new hobby, traveling, keep working, working part time only, volunteer, doing absolutely nothing, starting your own business, writing a book, doing up the house or becoming a philanthropist to name just a few ideas. There are many options, just think about some of the things you love spending time on!

The problem with time is that you can only spend it once, after that it will be gone for ever. You can’t rewind a moment and live it again or do something different with it.

Time is our most valuable asset and by achieving FI and no longer needing to work to pay your bills, you can be much more intentional with your time.

4. But I like my job! I don’t want to stop working!

Great if you enjoy the job, the projects you do, the results you achieve, the contact with other people or the daily structure that it provides you.

Luckily for you, becoming financially independent doesn’t mean you have to give up these things. Once you reach FI you need longer NEED to work for money, that doesn’t mean you’re not ALLOWED to! If your job gives you happiness, satisfaction and a sense of purpose or belonging, then by all means don’t walk away from it! In fact, many people pursuing FI like work and aren’t necessarily thinking about quitting their jobs.

What it does mean that if for whatever reason they no longer want to work (due to a change in family situation, a company structure change or for any other reason), they can just decide to stop whenever they want!

5. How can I reach FI?

If you’re keen to start working towards Financial Independence, your main objective should be to build passive income streams to replace your income.

Some common ways to do this include investing in the stock market, crowdfunding or investment property.

You can also create a semi-passive income stream that, although not fully passive, still only needs a much smaller amount of time to set up or manage. This can include blogging, online courses, selling craft on Etsy or really anything else that you are good at and enjoy doing and you believe people might pay for.

6. How do I know I’ve reached FI? 

You reach Financial Independence when your passive income can pay for your expenses.

There can however be some variation in this: do you want all your expenses covered (including those that are “savings expenses” to build up savings or investments?, do you want just the essentials covered or do you want to be able to spend even more than you currently are?

The road to FI has 8 different stages, so depending on which one you are pursuing, you are the only one who can decide whether you’ve reached FI!

7. What are these 8 stages of Financial Independence? 

Becoming familiar with the 8 stages of Financial Independence can help you determine where you are on your journey to FI and what your goal is, i.e. where you want to get to. They are:

  • 1 – Financial dependence – when you rely on others to provide for you. This is how we all start off in life!
  • 2 – Financial solvency – when you can pay your own bills and financial commitments, but likely have debt.
  • 3 – Financial stability – when you have some savings / emergency money set aside in case of adverse financial situations.
  • 4 – Debt freedom – when you no longer have any debt.
  • 5 – Financial security – when you have passive income that can pay your essential expenses, such as utilities, food, insurance, transport and housing costs.
  • 6 – Financial independence – when your passive income can pay for all of your expenses, including the discretionary (fun) ones.
  • 7 – Financial freedom – when your passive income allows you to splurge on some luxuries now and again: a fancy holiday, a second house or a more lavish lifestyle.
  • 8 –  Financial abundance – when money isn’t a problem anymore you really have no limits in terms of what you can pay and do.

8. How long does it take to reach FI? 

One of the main factors determining how long it takes to become Financially Independent is your Savings Rate, i.e. how much you save in proportion to your income.

You can calculate your savings rate by dividing the amount of money you save each month by your net income. Say you set aside $300 each dollar a month (putting this into savings, investments, crowdfunding projects etc.) and that your total net monthly pay is $1,500 then your savings rate is $300 / $1,500 * 100% = 20%.

The higher your savings rate, the faster you’ll reach FI. There is as excellent post by Mr. Money Mustache where you can find out how different savings rates affect your time til FI. In the case of 20% this would be 37 years. If you manage to save 30% then you can retire after just 28 years.

9. Do I have to earn a huge salary to reach FI?

As we saw in the previous question, your main most important factor to reach FI is your savings rate. Regardless of how much you earn you can reach FI. If you don’t make a lot of money, you likely spend a lot less too compared to somebody who earns a lot more.

The more we earn, the more we also spend, meaning we also need more money coming in from passive income to cover all those expenses! As long as you don’t plan on spending more than you currently are, there is no need for you to have a 6 figure salary!

But of course, if you are looking to get rich instead of reaching Financial Independence (or better said: if you are looking to reach stages 7 or 8 of the 8 stages to FI), then earning a lot of money will definitely be necessary.

And having a bigger income CAN also speed up your path to Financial Independence, but doesn’t necessarily have to: there are many big earners who don’t have any savings, simply because they are used to spending everything that comes in.

10. Where do I start?

If you are ready to start working towards Financial Independence, here are a few things you can do to get started:

  1. Start living off less: make small tweaks in your current expense patterns to save money.
  2. Save or invest your money wisely, and automate this process.
  3. Find ways to make more money (pick up extra hours at work, begin a side hustle).
  4. Treat your finances wisely: pay off debt, invest in your social security provision and learn about other ways to become financially literate.
  5. Keep on reading these next few blog posts, where I’ll be discussing more practical tips on many ways to work towards FI, including how to get your money to work for you and create those passive income streams!

This article is part of the “10 Common Question series”, where I address issues about some key financial areas, including Financial Independence, paying off debt, increasing your income, retirement provisions, saving, investing, financial protection and much more. If you want to find out more about Financial Independence, you can sign up to my newsletter to stay up to date or get a free sample of my book 100 Steps to Financial Independence. 

Image by Larisa Koshkina from Pixabay

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