How to pay off debt

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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.

Appartment	Study loans	Car	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.

Apartment	Study loans	Car	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.

Step 1: Stabilize your economy. Buffer and Savings

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This is the first step of my private economy, saving and investing series. Be sure to read the other posts as well:

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

As a first step before we even start thinking about investing is to lay out the foundations for a stable living. A buffer and a savings account.

Savings account

My old approach to saving was pretty much ad-hoc:

1. Get paycheck
2. Pay bills
3. Go on with life
4. Receive next paycheck and move whatever was left to the savings account.

Many times it was nothing, and some months I took instead of put money into the account.

Needless to say, it felt very hard to save for something specific.

The big issue with the ad-hoc approach is that there are a lot of variables in life and even if you cut away something, it is a long way for it to actually get to the savings.

The first change to do is to change the order of things. Namely, to put away money as the first thing instead of the last. This will result in a more deterministic savings.

Deterministic savings mean a lot of things.

• You will put away the same sum each month. 
• This allows you to plan your future financial situation. 
• You can automate it, meaning that it is more likely that you keep your plan if you never actually see the money on the spending account.

It also means that if you plan to save a certain amount each month, you need to stick to the plan. After the money hits the savings account, you should look at it as if it is out of reach and not usable. We usually refer to it as monopoly cash or toy cash. It looks and feels like real money, but you are not able to use it.

If you want to increase your savings per month, try removing from the other sections by for example canceling a subscription. Do you really read that magazine? Directly when you cancel, also change your automatic savings amount. This way you actually save the money and not just use it on something else.

The buffer

From time to time, life happens and your paycheck is not enough and you need to solve the situation by going to the savings. But in the section above we agreed that the savings account was off limits, how do we solve this?

By creating an extra account, preferably an actual account in the bank. How big this has to be is up to you, but the key is to always have it at the level that you have decided.

If you need to take money from it one month, you pay it back the next before all other savings or bills.

If you need to use the buffer continuously, then you need to change some habits. Maybe cancel a subscription, skip a restaurant visit or something similar.

Conclusion

In the end, it is not that much work but quite a lot of determination to keep to the plan. The key idea being to pay yourself first before doing anything else. Start small, and grow it over time.

Continue with step 2: Expectations and mindset

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.