Part 4: Tackle Your Debts

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In part 4 of the 10 Parts to Financial Independence we’ll be looking at what for many people can be their biggest financial worry: debts. Whether you’ve got thousands of dollars in outstanding loans, or just a small amount, the most important thing you can do is to take action now. This post looks at how to deal with your current debts and avoid building up any more.

Part 4: Tackle Your Debts

The first step in becoming debt free is to understand how expensive it is to have debts. When you take out a loan, be that on a credit card, a mortgage, student loan or car loan, you pay interest on the amount you’ve been lent. Over time, this interest quickly starts to accumulate as your interest is calculated over your outstanding amount as well as over any previous interest that was added.

This compounding interest means that a loan of $10,000 at a 14% interest rate and a monthly payment of $188 will have cost you $5,707 in interest after the 7 years it takes you to pay off the loan!

There are many free interest calculators available on line, so as a first task go and find one that seems easy to use and of all your debts calculate how much they are truly costing you in interest over time.

The next thing to do now that you have a better idea of how expensive debts are, is to avoid taking on any more debt. Make a mental note -or even better: a physical one and stick it on your fridge or in your agenda- to not buy anything on credit anymore, unless it is an asset that you believe will appreciate (increase in value) over time. A second tool to help you stop accumulating more debt is to make sure to finish building up the emergency fund you started in part 3. That should help you not having to go into debt for any important but unexpected expenses that come up. 

Once you’ve built up that emergency fund, use any money that you have lying around, from a yard sale you might be able to organise, or from your limit-one-expense challenge to start paying off ONE of your debts. Choose the debt with either the biggest yearly interest rate or the one that is smallest in total outstanding amount (whatever you think would make you feel more motivated) and start making extra contributions to this debt. Even if they are small amounts, you’d be surprised how much of a difference this can make over time!

On a debt of $1,000 at a yearly interest rate of 18% and a 3% monthly payment plan, paying just $25 extra a month on top of the 3%, means you pay off the debt in 31 months instead of 118 months and your total interest paid goes down from $779 to $221!

Lastly, make a commitment to yourself, your family and your future to become debt free. Treat this as one of your mayor financial goals to focus in over the next few years. Once you start working towards this, it will gradually become easier even if at the beginning this might feel like a daunting or impossible goal to achieve. Set a target date for when you want to be debt free.

Find some time today to look at the tasks above to complete to keep progressing on your path to Financial Independence!

This post is an adaptation of part 4 of the 10 parts in the guidebook to Financial Independence100 Steps to Financial Independence: The Definitive Roadmap to Achieving Your Financial Dreams where you can find more details as well as action plans and guidelines to each of the 10 parts. Available in both ebook and paperback format!

Get your FREE sample of the 100 Steps to Financial Independence Book here

Coming up next: Part 5 of the Journey to Financial Independence: Your Savings.

 

Step 70: Pay off your mortgage

Step 70 of the 100 steps mission to financial independence: Pay off your mortgage
Step 70 : Pay off your mortgage

Now that you’ve been through the various steps on expenses and budgeting, saving, pensions, investing and planning for your future, it’s time to go back again to the bit on debts with one debt in particular which is probably your biggest debt: your mortgage (providing you have one – otherwise you can skip this step). We of course spoke about paying off debt at the start of our mission, but as we said there, since your mortgage has a lower interest rate than most of your other debts, chances are you haven’t yet started paying it down faster.

As commented before many people would argue that a mortgage is a different type of debt and therefore not to worry about as much as they see having a mortgage as an investment. At the end of the day they say, your house is an asset that will probably increase in value over time. I disagree for several reasons:

  •  first of all it isn’t the same type of assets such as stocks and bond that you can just sell to generate some extra money. The only situations in which you can argue that your house is an asset like any other is when you don’t need it anymore for example because you decide to:
    • travel
    • move in with somebody else
    • live in another house that you already own or rent
    • scale down and don’t need a mortgage on a new house
    • live on the streets
  • secondly, you never know when you can sell your house. Some houses are on the market for years, so liquidating that asset isn’t as easy as with other assets.
  • thirdly nothing guarantees your house will truly increase in value or have increased in value by the time you need or want to sell. During the recent house market crash, many houses were sold below their original purchase price.
  • fourthly you are still losing money by having a mortgage in the form of interest payments and you are tied to paying back regularly so until you pay off your mortgage in my eyes this is a debt that takes a big toll on your monthly finances.

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