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 94: Beware your Credit Score

Step 94 of the 100 Steps Mission to Financial Independence: Beware your Credit Score
Step 94: Beware your Credit Score

Your credit score is important when you want to qualify for a loan, such as a mortgage or a car loan, or many other financial products including insurance policies. Only with a high credit score will money lenders want to give you a loan. If your credit score isn’t high enough they won’t want to give you a loan, meaning you either won’t be able to buy your house, or you might only be able to get loans with high interest rates. Nowadays some employers even check credit scores of job applicants so maintaining a positive score is truly important not just in order to get a loan but potentially also when it comes to applying for a new job.

The importance of having a high credit score:

  • It gives you lower interest rates on loans and mortgages. As you know by now, even small differences in percentages can make a huge difference over time.
  • Landlords usually evaluate rental applications on credit scores as with a higher credit score they believe you are less likely  to default on your payment of the rent.
  • Other financial products such as insurance policies as well as investment opportunities are sometimes only granted to those who have a sufficiently high credit score.
  • Certain companies and employers don’t hire people with low credit scores as they believe these people have less self-control and are less goal-oriented.
  • Higher credit scores increase your chances of getting a higher credit limit. This in turn helps you decrease your credit utilization rate (see further below)

Tips to improve and maintain a credit score:

  • Don’t ever default on a credit card payment. At the end of each month make sure that you pay the minimum you are required to pay.
  • Start paying off your debt, this shows that you are a responsible person looking to reduce your debt instead of constantly living with outstanding amounts.
  • Once you’ve paid off all outstanding credit card debt, make sure to pay off your credit card in full at the end of each month from now on.
  • Maintain a low credit utilization ratio, i.e. the percentage of your credit limit you use. Try and keep it below 30%. For example if you have 3 credit cards with a $1,000 limit, aim to use no more than $900.
  • Don’t apply for credit too often or for too long. A credit company will keep track of any inquiries they receive and if somebody has been marked with having made lots of enquiries or over an extended period of time, your score again goes down.
  • Close cards you are no longer using. This might reduce your credit utilization percentage, but having many different cards also imposes a risk of fraud, theft and temptation to use more than you need.
  • You usually get a better rating for cards that you’ve had for a while, so avoid closing long-term cards.
  • Keep track of your credit score regularly, e.g. monthly. You can easily check your credit score online.
  • Start build your score early on. The longer you give it time, the better your score.

Continue reading “Step 94: Beware your Credit Score”

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”