fredag 27 januari 2017

How to pay off debt

Woman taking a picture of sunset at sea with her smart phone

This is a follow up on my previous post 'Reasons to avoid Debt'.
Say that you already are in debt and want to start taking care of it to get a little peace of mind, but don't really know how to do it. Here's some ideas that might help you.

Start paying off the smallest debts first

This way you will get rid of them fast, and also free up cash that in turn can be used to pay off the next smallest debt that you have.
I think that many people want to get rid of the big debts first as they are the ones that hurt the most, but it is hard to pay off more than you already do on them as the rest of your money is going to other loans.

Lets picture a scenario

Random person X has the following debts at the moment, not taking into account interest rates etc. Just calculated on X months left and how much it costs per month.
Study loans
Samsung Curved 65" 4K
iPhone 7 128 GB
€300000 €5000 €18000 €2000 €750
€800/375 months €60/83 months €350/52 months €166/12 months €62/12 months

As we can see, the living expense is the highest per month. After that comes the car. First ask yourself the question do I need to live in this expensive appartment or drive this expensive car?
If for any reason you answer no to any of the debts you have, get rid of the item. Buy a cheaper one, or not at all? DO you need a TV? :)

If you feel that you could downgrade:

  • Sell the item
  • Buy a cheaper one
  • Use whatever money is left to pay off the loan
  • Continue to pay off whatever is left on the loan.
Hopefully this tactic has cut of a couple of months on your payment plan.

If you need the things but want to pay them off quicker

Ok, So somewhere you need to get the extra cash to start paying off your cheapest loan, in this scenario the cellphone. If you can muster an extra €60 per month for a while by cutting other expenses you will have paid the phone in 6 months.
After 6 months, you have learned to live without that €60, and also freed up another €60 so you have €120 extra per month to pay off another debt.
Next small fee per month would be the study loan, but it has so long term left. At this point 77 months so lets focus on the TV.
The TV has 6 months left, but with the extra €120, you can pay it off in 3.5 months, so 4 months.
After that you have €286 per month to work with and we are 10 months in.
Study loans
Samsung Curved 65" 4K
iPhone 7 128 GB
€292000 €4380 €14700 --
€800/365 months €60/73 months €350/42 months - -

At this point you start to get options. I would recommend you to start setting up a savings account if you don't already have one, say €50 per month as a started, you still have €236 to pay off next debt with. So lets continue our scenario.
Study loans in 15 months or Car 25 months. Lets look at both

Option 1, pay the study loans first
After 15 months, you would up your paying power to €316 and then be able to pay the rest of the car in 14 months. Total of 29 months.

Option 2, pay the car first
After 25 months, debt paying power is up to €586. Study loans paid in 5 months. Total of 30 months.

So, I guess we will go with study loans first. So after a total of 39 months, 3 years plus some change you have paid all your loans but the apartment and should have 1450 on your savings account, not to mention the extra €646 per month that you can use to build up your buffer and start investing. You could also use it to pay off a bit on your apartment to minimize the risk if the house prices should turn down.

Be sure to read my series on how to stabilize your economy:

Step 1: Stabilize your economy
Step 2: Expectations and mindset
Step 3: Index funds

Until next time: Work to Live, Don’t Live to Work

Disclaimer. I am in no way an expert on capital management or investing. On this blog I only wish to share my findings, ideas and comments on current events and fields that interest me. I hope that my thoughts can entertain you. I expect that everyone reading take their time and do their own research before acting on anything read on this blog. Investing is not for everyone. E&OE.

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