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

Part 2: Define Your Starting Point

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

After setting your goals to Financial Independence, the next part of your journey is to determine your current starting point. With those two things together, i.e. where you want to get to and where you currently are, it’ll be a lot easier to plan out how to achieve your goals.

Part 2: Define your Starting Point

One common obstacle to achieving financial independence is consumer debt. Most people have some type of debt they have to deal with and pay off, such as student loans, credit card debt, car loan and / or a mortgage. The first step in determining your starting point is to list all of your debts with their current outstanding amounts (i.e. what you still owe) and then total those amounts to get an overall amount.

While debts represent the negative side of a financial picture, most people also have a positive side: their assets or possessions that are worth something. This can include anything from a house to a savings or investment account as well as antique or art of a certain value. Do the same as what you did with your debts: list anything you own along with its estimated value and total those amounts.

With these two numbers you can now calculate your net worth: a very useful indicator of how healthy your personal financial situation is. Simply take the total value of all your assets, then subtract the total amount of debts you have to find your current net worth. Note that this might be a negative number!

Lastly as part of determining your starting point, it’s a good idea to get a solid overview of your current expense patterns. Not only does this help to see where your money is going, it will also come in useful when you start setting goals later on in your journey for the various financial areas we’ll be looking at. Start logging your expenses on a daily basis to get a good idea of what you spend your money on.

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

The above is an adaptation of part 2 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!

Coming up next: Part 3 of the Journey to Financial Independence!

Day 9 / 31 Start paying off your debts

Day 9: Start paying off your Debts

Day 9: Start paying off your Debts
Day 9: Start paying off your Debts

Today’s challenge is to put in a plan of action to start paying off your debts. Now that you have seen how much a debt costs you and how much extra you are paying in interest in yesterday’s challenge, this is probably the best moment to kick those wretched loans to the curb as soon as possible.

Once you start paying of your debts you are beginning to regain control over your financial life, little by little lifting the strain of monthly payments and the psychological burden of being indebted to somebody else. Continue reading “Day 9 / 31 Start paying off your debts”

Step 55: Discuss Finances with your Partner

Step 55 of the 100 steps to financial independence: Discuss Finances with your Partner
Step 55: Discuss Finances with your Partner

I admit that this step should have probably been way earlier on in the list, since if you share your household and finances with your partner, then discussing money matters and making sure you have the same short-term and long-term goals in mind is essential to not only achieving your financial goals but also keeping your relationship healthy and happy. At the end of the day if you are trying to save, invest or grow your capital whilst your partner is more of the “let’s spend it all now” school, you likely both wind up frustrated with each other, meaning both your financial goals and your relationship happiness will take a hit and suffer at some point.

Sad but true: finances and a lack of shared financial goals or financial compatibility are not uncommon reasons for people to end a relationship, so let’s get this sorted once and for all and make sure that you and your partner discuss your individual and joint financial beliefs and goals. You might not have exactly the same ideas about how to spend or save your money, but discussing will at least create more understanding and hopefully pave the way to an agreement that satisfies both and leaves some (financial) room for both to do your own thing.

Of course it might be that your partner is not into finances at all and is happy for you to take control of the (majority) of the money decisions and responsibilities. If that is the case, it might sound easier in the short-term to simply assume that role not inform or even consult your partner, but remember that long-term this might not be in the interest of neither your relationship nor of your finances. Continue reading “Step 55: Discuss Finances with your Partner”

Step 24: Become debt free

Step 24 of the 100 steps mission to financial independence: Become debt free
Step 24: Become debt free

Becoming debt free might or might not have been a goal you identified when you put together your principal financial goals in step 2. Whether this was the case or not, you hopefully have realized that becoming debt free is possible with some extra effort and money, and in your interest (no pun intended) if you want to avoid paying the extra costs of oustanding loans. It might take you three years, 10 years or 20 years, but being able to say you have finally paid down all your debts is a huge achievement. And as we saw in the last few steps, the time it takes to pay off a debt can be sped up incredibly by making extra payments.

The next part of your mission and the main focus of this current step is for you to set yourself goals to pay off your debts. You will set yourself a target date to pay off the first debt that you have already started working on, then for each and every other debt you will do the very same, all the way to the very last debt you will be attacking. That will be your target date to becoming completely debt free. Continue reading “Step 24: Become debt free”

Step 23: Start paying off 1 debt

Step 23 of the 100 steps mission to financial independence: Start paying off 1 debt
Step 23: Start paying off 1 debt

From the previous step you are now up to speed about the positive effect of extra payments on outstanding debts. That leads us to the current step: start paying off a debt. You might think you are already paying off a debt, or several of your debts, but the point here is that you are going to pay off a debt faster by making higher monthly contributions than the minimum required.

When you pay off a debt faster than scheduled, a few amazing things happen:

  • You end up paying less interest, resulting in a lower amount of money paid back overall;
  • It takes less time to pay back the loan, meaning you can tick it off your list a lot sooner;
  • Psychologically it is a great relief to have paid off a debt: one less thing to worry about;
  • It increases your motivation by showing you that you can achieve your goals;
  • And here’s a great thing: once you’ve paid off a debt, that monthly amount you poured into this debt suddenly becomes available, which you can then use in its entirety to pay off another debt, meaning it keeps up that momentum!

Continue reading “Step 23: Start paying off 1 debt”

Step 22: The impact of extra debt payments

Step 22 of the 100 steps mission to financial independence: The Impact of Extra Debt Payments
Step 22: The Impact of Extra Debt Payments

After some rather depressing news to do with debt and interest, it is again time for some uplifting information. In this step we are going to look at how powerful it can be to put extra money towards paying off a loan and how much it reduces not just the time spent on paying back the money, but also the total amount paid back.

This information will hopefully inspire you to find ways of making extra payments towards reducing your debts. As even if they are small extra payments, in the long run, thanks to that friend of ours called compound interest, it will have a huge effect.

Let’s go back to the same example as the one I used in step 21 to illustrate how credit cards work, in which we looked at an outstanding debt of $1000, at a 1,5% monthly interest rate and a payback rate of 3% with a minimum of $10. But this time you make an effort each month to pay the minimum amount (3% of the outstanding debt) and an EXTRA $25 on top of the minimum amount. Let’s see how this works out. Continue reading “Step 22: The impact of extra debt payments”

Step 21: Stop accumulating debt

Step 21 of the 100 steps mission to financial independence: Stop accumulating debt
Step 21: Stop accumulating debt

It’s time to start looking at an area of your finances that makes many people nervous, scared and / or depressed, leaving them ignoring rather than analyzing and planning how to deal with that very same area: debts.

Yet in order to become financially independent and in total control of your finances, it is important to understand how debts work and how even seemingly small debts or amounts can make a tremendous difference to your long-term finances.

In step 4, you listed all of your debts, so you should have a good idea of how much debt you have and how much you are paying towards amortizing these loans. In this current step we are going to look at the effects of debt and how much extra you end up paying on any long-term debts. Continue reading “Step 21: Stop accumulating debt”

Step 7: Set a Net Worth Goal

Step 7 of the 100 steps mission to Financial Independence
Step 7: Set a Net Worth Goal

Our next step of the 100 steps mission to financial independence is to set yourself a goal for what you would like your net worth to be in six months. This gives you an excellent target to work towards to during the mission. Although you’ll probably find that your net worth doesn’t change dramatically in this half a year, 6 months is a good time frame to start with as it is long enough to see substantial changes and the effects of goal setting, yet short enough not to forget about it or lose track.

You can set yourself a goal for your net worth by either stating a specific amount, or alternatively by setting a percentage by which to increase your income. If you set a specific amount as your target and keep that the same every six months, with time as your net worth increases and as it should become easier to achieve the same target, you might not be achieving as much as you could. Alternatively, if you set yourself a target of certain percentage increase it means that your net worth target increases more as your net worth itself increases.

Continue reading “Step 7: Set a Net Worth Goal”

Step 6: Calculate your Net Worth

Step 6 of our 100 steps mission to financial independence
Step 6: Calculate your Net Worth

In this 6th step, you are going to determine your overall financial starting point by calculating your net worth. I know the words “calculate” and “net worth” might be putting you off, but this step is a lot easier than it might sound, as we have already done all the preparation work in the last few steps by digging up financial statements and creating our assets and liabilities lists in step 4 and 5.

Your net worth basically indicates what would happen if you decided to sell all of your possessions and pay off all of your debts today: would you any have money left over or would you still be in debt? How much money would you have left over or how much money would you still owe? Your net worth is an easy sum of your total amount of assets minus your total amount of liabilities. Continue reading “Step 6: Calculate your Net Worth”