Reducing Personal Debt

I believe one of the best ways to financial freedom and surviving on a low income is to reduce your personal debt.  When I talk about eliminating debt I am talking about credit cards, personal loans, and money loaned from family or friends.  Whilst a mortgage is debt it is a positive debt, that is a mortgage eventually gives you the financial freedom of owning property and in the long term property values tend to increase.  Also you need to pay for accommodation whether that be rent or a mortgage and I personally prefer to pay off a mortgage than someone else’s investment property.

The only debt I have is a mortgage.   I used to have a GE Credit Card that I solely used for the interest free promotions but I cut that up three years ago and now pay cash for big ticket items from savings.  The freedom of not owing money (other than my mortgage) and being able to pay cash is quite liberating.

It is important to pay off debts as quickly as you can as this frees up money for you to use to live.

Best ways to eliminate debt

1. Cut up your credit cards!
2. List all your debts: include all money you owe – credit cards, mortgage, personal loans, loans from friends or family.
   

   Image courtesy of Stuart Miles/freedigitalphotos.net

3. List these debts in order of amount owed.
4. Pay out the smallest debt first whilst still paying the minimum payments on all other debts.  Roll your credit card onto a 0% on balance transfer credit card – some of these are for six months but you can find some for 14 months.  That means 14 months of NO interest as long as you don’t use the card so CUT IT UP!
5. When you’ve paid out the first debt put the money you had been paying to that onto the second smallest debt and pay that out.  Keep doing this until the only debt you have left is a mortgage (if you have that).

N.B. If you have a mortgage and a lot of credit card and personal debt it could be beneficial to refinance your mortgage to incorporate all these debts.  You would then only have one repayment (for the mortgage) but you could pay a lot more off your mortgage each week by using the money that was going on the other debts to pay down the mortgage.  Talk with you mortgage lender to see if this is possible for you.

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Example

Peter and Monique are working on their budget and have decided to focus on reducing debt as a matter of priority.  They sit down and list everything they owe:

• $160 – Monique’s sister
• $1450 – Credit Card (monthly payment is $30)
• $2520 – personal loan (monthly payment is $100)
• $254000 – mortgage

They have decided that they want to get rid of the debt as quickly as possible.  They cut up their credit card.  They start their debt journey by putting $50 per fortnight aside to pay Monique’s sister back.  In four fortnights they have paid her back.

This now frees up $50 to put towards the credit card debt.  They use a balance transfer for their credit card to get 0% for 14 months and pay the credit card minimum payment (set at 2% of the card limit so about $30 per month) PLUS the $50 per fortnight.  They will have the credit card paid off in about eleven months and now have $30 per month and $50 per fortnight available for the personal loan.

They put these amounts PLUS continue the minimum loan repayments for the personal loan so they are now putting $130 per month and $50 per fortnight to the personal loan.  In about another year they will have that paid off as well and be debt free except for their mortgage.  If they use lump sum payments such as a work bonus or a tax refund they can reduce their debt even faster.

They can then start putting the $130 per month and the $50 per fortnight into their mortgage which reduces the overall term of the mortgage.  They have set themselves up well by reducing their debt.

 One final point

Image courtesy of Stuart Miles/freedigitalphotos.net

I really believe that getting rid of your credit cards is your first step towards financial freedom.  Credit cards by nature are designed to make you spend and the more you spend the more interest your lender is making from you.   A credit card is not your money, it’s the bank and you will have to pay it back.

It is much better to get yourself a Visa debit card that is offered by most banks these days.  Visa debit cards have the benefit of working like a credit card both in traditional brick and mortar shops and online but you are using your own money.

You can also purchase prepaid Visa cards now that allow you to put money on the card and use it like a normal credit card but again it’s your own money and there are no interest charges.  When you are using your own money you tend to think twice about spending on your card.