Editor’s note: I’ve been writing a book on how to pay off debt fast in secret. Now, the secret is out and I’m publishing it as a series of posts (initially). Hope you find it useful and enjoyable to read. Mainly, I hope that now that the strength of your resolution has weakened, it helps you to stay focused on paying off debt. Oh, and this one is long. To be specific over 8,000 words long. To make it easier to navigate, I’ve made a mindmap of it; and feedback is very welcome.
Yes, that’s me and I know a thing or two about how to pay off debt fast. Because I’m the woman behind paying off debt of £100,000 in three years flat.
We became debt free (except for the mortgage but we are working on it) in the first week of February, 2013. I was facing a large roomful of students when my phone pinged. John’s message said:
‘Done and dusted!’
You know what?
I’ll never forget the heady mixture of elation, fulfilment and pure joy I felt.
I want you to feel it as well!
Apart from that, you can’t achieve financial health and have a lot of consumer debt (this is all debt except mortgage).
This is why, I decided to write this guide to paying off debt. I’ll share the only secret to paying off debt fast; I’ll also tell you exactly what I (we) did to pay off so much debt in such a short time.
You can do it as well: you just have to stop making excuses for yourself. Yes, I know…
- My circumstances are different.
- My numbers are rather outlandish.
- My ambition is outrageous.
This may be so.
However, the principles, attitude hacks, techniques and tools shared here can be used by anyone, anywhere: you just have to have the ‘debt busting lust’.
The rest, as they say, will soon be history.
Now, grab a notebook and a pen, make yourself a cup of coffee and let’s go. This is what we’ll be working on today:
I can’t wait! Can you?
The secret is out: this is all you need to pay off debt fast
People often ask me how we managed to pay off debt so fast.
I tell them that my strategy for becoming debt free was very simple: earn as much as you can, spend as little as you can and use the difference to hit the debt. Then spend some time watching it crumble and celebrate.
This is when people tell me that I’m lucky because I can earn more. They tell me that my numbers are ‘mental’.
You know, friends, this has next to nothing to do with luck. Yes, I can earn a lot but I do work very hard to keep at the forefront of my profession. I also use every opportunity to learn and have trained myself to be very good at spotting and mobilising opportunities. Being ‘at the right place, at the right time’ is a matter of preparation, strategy and initiative; not luck.
As to my numbers, yes they are a bit ‘mental’.
- We had £100,000 worth of consumer debt.
- At the moment we make more than this annually between us (we did increase our income a lot since we first found out about the debt).
- Now we have a new goal: to have £2,500,000 (or the equivalent which is £10,000 passive income per month) by October 2018.
But you know what? Coping with my ‘mental’ numbers is easy.
First, remember that I arrived in the UK, 25 years ago, with $20 in my pocket. Yes, seriously.
Second, you can just cut a zero or two off the end. You see, if you have £10,000 worth of consumer debt and you make £25,000 per year you are roughly in the same situation we found ourselves in 2009. (I’ll explain why £25,000 and not £14,000 in one of the follow up posts).
What I’m saying is:
Don’t be distracted by my numbers, by thinking me lucky or simply by seeing me as a ‘rich, stuck-up bitch’.
Start paying attention to the one thing that matters for how to pay off debt fast. Here it is:
The secret to paying off debt fast, and staying debt free forever, is learning
Now, when people ask me how to pay off debt fast I tell them:
Learn to control your money if you don’t want money to control you.
Control is often misrepresented as discipline and seen as restrictive. This is not what I’m talking about.
I’m talking about controlling you money by:
- Having information and knowledge;
- Having standards that allow you to decide on specific course of action; and
- Taking certain actions (and making habits out of these).
This is all you need to pay off debt fast and stay debt free.
This is why I’ll tell you:
- My (emotional) take on debt and the wonder of being debt free;
- What you need to know, and what information you need, to pay off your debt fast;
- About ways to decide how to tackle your debt (some will call this ‘strategy’); and
- What actions you need to take to pay off debt fast.
(The first and second points are largely covered here. The other two points will be in separate posts.)
I’d also have to tell you that this post is long. I could have made it shorter but then I would have been sacrificing the opportunity to help you pay off debt for entertaining you and not over-loading you.
My choice was to do the best I can to help you pay off debt; this is why researching and writing this series of posts took me over 60 hours work. I’m offering you the result FREE.
Whether you spend couple of hours reading it is your choice. Still, I so much hope you decide to read further!
Reading this post won’t be enough; you’ll have to do the things I tell you to do and then stick to it for a year or two. Can you do this?
(If you can’t, there is no point reading further; my object here is not to entertain but challenge to action. Well, not only entertain anyway.)
Remember the notebook, pen and cup of coffee I mentioned earlier? May be it is time for a refill.
Let’s talk about debt, baby?
I know debt intimately.
In my youth, debt was a casual acquaintance. I will run out of money and survive the month by borrowing a bit from friends. Than pay it back.
Later debt became an ignored suitor. In my late 20s my life changed: I had a wonderful husband, two step children and a truck load of consumer debt. I ignored the debt completely, I refused to think or talk about it. I focused on the people I loved, instead; I focused on my career.
This is how debt became my formidable enemy. In 2009, when I was in my mid-40s, I found myself pacing in a hotel room in Lausanne (Switzerland): we’d reached a crisis and the debt couldn’t be ignored any longer.
The evening before, between sips of smooth Malbec, my husband cleared his throat and said:
“Darling, we seem to have built a bit of debt.”
For me ‘a bit’ would have been anything up to £5,000.
‘A lot’ would have been around £15,000.
What my husband said next made me spew my wine and swallow my words.
We had consumer debt of around £100,000 ($160,000).
Would you sleep peacefully if you had so much consumer debt?
No, I didn’t either.
I paced, I cried and I raged. I was scared, upset and without future.
Do you still wish to know what it felt like?
It felt like I had been dropped on a very high and steep mountain peak.
I looked down, my head spinning with vertigo, my belly knotted with fear and my mouth dry with anxiety. There was one thought in my head:
“I can’t f*cking do this.’
Next, debt became my worthy adversary. One morning, weeks after the unfortunate night in Lausanne, I woke up and simply knew that enough is enough: I’ll fight the debt and I’ll win; I’ll take back control.
This is when I started learning, strategizing and acting.
We did fight and we did win! It took us three years (okay, and a week) to pay it all off; all £100,000 ($160,000) of it and with the interest.
Now, debt is my supportive angel. We’ll never be in debt again; I’ve made sure of that. But I still look back, smile and think that if I were able to do this, I can do anything.
So you see, I know a thing or two about debt.
I also know about being debt free. To me being debt free means beauty, freedom and opportunities.
It also means I stopped fearing:
- My phone ringing;
- Letters from the bank;
- Losing our house;
- Stealing my son’s future;
- Older age; and
- The drudgery of life itself.
Instead, I learned to love:
- Buying flowers;
- Watching our wealth grow;
- Hustling; and
- Dreaming about a great future with John.
If you are still reading, you are probably on first names with debt as well.
Are you ready to make your debt a memory of strength rather than a shadowy threat stalking your future?
Let me tell you; if I managed to pay off debt in such a short time, you can do it too. After all, I do belong to the ‘I can resist anything but temptation’ club.
“Okay, but what do you offer others don’t?” – you may ask.
Many pages have been filled with ‘advice’ on how to pay off debt. This, in a nutshell, boils down to telling you that paying off debt is easy; you only have to make sure that:
There is always money left in your account at the end of the month;
You throw it all on the debt without fail and until it’s gone.
That’s it. And in theory this is how it works; this is how we did it.
Still, in practice, too many people still in debt. In the UK alone, the level of household debt has increased by over 300 per cent between 1990 and 2013.
Experts have written a lot about how to pay off debt. Why are more people getting into even more debt?
And here is where I break with tradition (and the reason you should probably read what I’ve written and do what I say).
You see, to learn about paying off debt you need an ‘expert’ who knows.
To pay off your debt fast you need a ‘maverick’ who knows many things and has lived what they preach.
Because, paying off debt fast requires:
- Knowledge and action;
- Information and wisdom;
- Innovation and experience; and
- Inspiration and belief.
Most of all, it requires that you change your thinking and your approach to life.
This is what I offer you!
- I offer the knowledge I gained and a blueprint of what we did.
- I offer the information I collected and the wisdom to make sense of it.
- I offer the experience of many who have paid their debt and the innovations we made.
- I offer the inspiration of knowing that it is possible.
- I also offer support without judgement and condescension.
Keep reading and taking action.
When you are finished with paying off debt, let me know – you’ll owe me a beer!
All you need to know about how to pay off debt
It is time to ‘grab the bull by the horns’, friend.
Or if you prefer, it is time to grab the debt by the balls and pay it all off. One thing that you have no time for – and I would have wasted my time writing this to offer you support – is continue to accumulate debt.
Because debt is a bit like carrying excess weight: it doesn’t stay still. You have a clear choice: you commit to positive change and lose it, or it keeps creeping up.
Do I have your attention?
Great. Now have your notebook and pen handy: this part is about the things you need to know, and the information you need to collect, so that you pay off debt fast; or pay off debt at all.
Six early warning signs that you are in too much debt
How could one be in too much debt and not know about it?
You may be surprised. Five years ago I had the feeling that all is not well with our finances; but did I know we have so much debt? No.
Here are the six signs that you may be in too much debt.
#1. You have ‘the feeling’: This is difficult to explain but before I even did my numbers I had a feeling that things are not right. My worry about money kept coming to the surface and I kept pushing it back. ‘The feeling’ is difficult to pinpoint but anyone who is in serious debt would instantly know what I am talking about.
#2. You don’t look at your financial statements: This is very common behaviour in people who have the feeling of impeding financial doom but don’t have the guts to check exactly how bad it is. I didn’t look at a financial statement for almost a decade; I know!
#3. You have no idea how much is in your bank account: This is an immediate consequence of not looking at your financial statements; because you never check, you never know. It also may be a sign of wilful neglect for money and this is really not a healthy attitude to maintain.
#4. You think ‘my problem is so much bigger’ when you buy things you don’t need or want: Oh, yes. This is exactly what went through my mind every time I bought something. And of course, my problem became even bigger than it was.
#5. You have no idea how much a pint of milk or a loaf of bread costs: We are talking basics here. Still, you should have seen my face when a friend went to her fridge, took out a pint of milk and asked me how much it costs. I had absolutely no idea: it could have been 20 pence, it could have been 20 pounds. Problem is, if you don’t know how much you pay for a pint of milk it is unlikely you will notice any other spending.
#6. You are surprised every time you open your wallet: Yep, you either have too much money in it or too little money. But you never really know what to expect. Whilst this is certainly a way to make your life that that much more exciting it is also a sign that you are not in control of your money.
How many of these signs did you spot in yourself?
If you spotted three or more of these signs, you need to take action and fast. Fail to tackle your debt and you’ll drown in it.
Commit to seeing it gone and you’ve committed to transforming your destiny.
Now, take a deep breath and keep reading.
Three stages of paying off debt
People will tell you not to compare yourself to others. You can try this one and I wish you luck; although I know that you’ll fail.
How do I know this? I know because science, as in behavioural economics, says so. Our very existence depends on our ability to adapt and to be able to adapt, we need to make comparisons. You can decide to go against evolutionary rule but I’d have to short you on this one.
You cannot help making comparisons. What is important than is to compare properly. Or as a friend of mine wrote ‘never compare your beginning with someone else’s middle’.
To avoid doing this when you are paying off debt, you need to be aware that there are three stages of debt repayment. These are:
#1. Stabilisation: This is the initial stage where you make sure that you’re not getting in more debt and can make debt payments that reduce it (even if very slightly). This is the paying off debt stage at which you:
- Gather all information about your debt;
- Know your monthly income and spending;
- Look at spending and reduce it in obvious ways.
Please keep focused. Remember, the fasted way to ensure that your monthly income exceeds your spending is to reduce your spending.
And I’m not saying that it is the best or most efficient way; just that reducing spending works so fast that you can be through with this stage in couple of months – it took me exactly seven weeks.
The most obvious places to look to cut spending are:
- Monthly payment on debt (how to do this is explained later on);
- Utility bills (this can take a bit longer);
- Insurance (look for cheaper insurance if you still need it);
- Your ‘variable’ expenditure offers the fastest gains: food, clothes, coffees, lunches out and other spending. Sounds like ‘small fish’ but I used to spend over £300 every month only on lunch and coffee at work.
During this stage of paying off debt, the main results you’d feel are on your confidence – once you get to a positive cash flow you’d know that you can do it.
You’ll need to get to the next stage to see results with your debt.
#2. Expansion: Now that you’ve stabilised your finances, you can focus on ways to increase your cash flow (and use it to overpay debt). This is best done by a combination of becoming a frugal artist and by increasing your income.
Working to increase your income sounds scary or unrealistic, depending on how you feel at the time. It works, though. I’m yet to meet someone who decided to increase their income and failed.
During this stage of debt busting frugality takes the back stage and you have to focus on making more money.
#3. Acceleration: Once you’ve ensured that your budget is as tight as well fitting corset (stabilisation) and that you have different income streams (expansion) you’d notice that paying off debt happens at a neck breaking speed.
You are paying off debt so fast that it is literally crumbling under your two-pronged assault.
Once you reach the half point – this is half of your initial debt – the speed to being debt free will increase even further. This is because you start to pay more principal than interest. (Put simply, this means that larger proportion of your payment goes towards paying off debt and a smaller part pays the interest on the debt).
It is important to know at which stage of paying off debt you are at any point. You don’t really want to get impatient at the ‘stabilisation stage’ or complacent at the ‘acceleration stage’.
Still, to pay off debt fast you have to get to the ‘acceleration stage’; staying at the ‘stabilisation stage’ would get you there, and you may pay off your debt, but very, very slowly.
I don’t know about you but when I was in a lot of debt I couldn’t wait to be rid of it so that I could start my debt free life (as I suspected, it is rather glorious). If we stayed at the ‘stabilisation stage’ we’ll still be paying off debt.
I shudder to think about it.
What are the options for tackling your debt?
There are four clear cut options when it comes to tackling your debt. You can: a) do nothing; b) choose IVA; c) go bankrupt; or d) pay off debt.
(Note: There are equivalent arrangements in the US; IVA is just a different way to go bankrupt in the UK.)
#1. Do nothing
Of course, the zero option is that you do nothing; which is convenient in the short run and devastating in the long term.
There is no point writing more about this one: it is not an option. If ‘do nothing’ is the best you could do, it will be better if you stop wasting your time and go do something else.
#2. Do an IVA
IVA stands for ‘individual voluntary arrangement’ and means that you’ll be paying off your debt but at a rate (amount) you can afford. IVAs usually last for six years and at the end any remaining debt will be written off.
If you can’t afford to make ‘normal’ payments to your debt, IVA is probably a preferable option than bankruptcy.
During an IVA, you’ll be paying at an agreed rate you can afford, your creditors can’t contact you and can’t be increasing your debt and you can keep your house (if you own one) provided you keep up with mortgage repayments.
Naturally, being one of the more extreme way to deal with debt, IVA has some problems. These are:
- Doing IVA will completely ruin your credit score. You may think that this is not that important given the gravity of your situation but let me remind you that lately landlords have started using credit scores when deciding to lend their property. Just reminding you that credit scores don’t matter much only if you have somewhere to live and don’t need to borrow. If you need to check your credit score, you can use Cafe Credit.
- Should the IVA fail, your creditors can backdate interest or even insist on making you bankrupt.
- You’ll need to live on a very strict budget till the end of the IVA. Now this, I don’t think is a bad thing if you use the experience to learn.
- Now, this is about your house. Remember I said that when going down the IVA route you can keep your house? Well, there is a snag. You can keep it but six months before the end of the IVA you’ll be asked to re-mortgage to release equity. This needs to be watched carefully.
#3. Go bankrupt
One thing I remember from the day after we realised the true depth of the debt hole we had dug ourselves in really, is that all I wanted was for IT to go away. All fight was knocked out of me by the nasty surprise.
Making all your debt go away is possible: it is called bankruptcy or sequestration if you live in Scotland. Tempting, isn’t it?
All your unsecured debts written off in an instant and no further calls from creditors, no bailiffs knocking on your door and no sleepless nights painting un-imaginable horrors and deprivation.
Thing is, bankruptcy (sequestration) is a very serious matter in the UK and has serious consequences for your life and career.
To begin with, it is a way to deal with debt only when you really can’t pay it off under any other conditions.
Next, going bankrupt in the UK means that all your assets may (probably will) be included in the deal; your assets may be sold to cover some of the debts. There is good news: pensions that are in ‘approved pension schemes’ won’t be included in the estate (you’ll be able to keep those). You are still likely to lose everything else, though. And, I know people who have gone bankrupt and their ‘new start’ is very much like the one that got them in the whole mess in the first place.
Last but not least, going bankrupt in the UK means that you cannot hold certain jobs (you can’t be charity trustee, insolvency practitioner, justice of the peace, part of local or national government etc.). Even more importantly, you cannot be a company director: this means that you cannot start a company either.
You see, bankruptcy may seem like an attractive option when you are still in the shock of discovery. In the UK, it has to be considered only as a last resort and after consultations with insolvency and debt relief practitioners.
#4. Pay off your debt
Last but not least, you have the option to decide not to share your life with debt any longer and pay it all off.
If you are not determined to pay off debt fast, you may as well stop reading this now. Don’t waste your time; go shopping, spend some more money and get in a bit more debt.
Why I think people should pay off debt?
When we paid our debt off our story got on the Business Insider. Some reactions surprised me.
One reader said:
“Why would any sane person with that much debt ever pay it back?”
And another one stated:
“Stupid people. They should have filed for bankruptcy…”
So, you see, one questioned my sanity and the other my intelligence.
Which I don’t usually mind but it has been almost fifty years since I was on the primary school playground and someone called me ‘stupid’ (and got away with it).
All because we paid off an obscene amount of consumer debt!
As the person who called me ‘stupid’ helpfully pointed out one possible solution to debt is bankruptcy.
I already told you why going bankrupt is not an option that should be taken lightly; particularly not in the UK.
There were other options open to us. We could have sold our house, for instance, and used part of the equity to pay off debt.
Problem is, we did sell assets to pay off debt before. And you know what?
We always found ourselves in debt again.
This time, we chose to pay our debt off the old fashioned way: by increasing our monthly positive cash flow and putting it all against the debt for three years; without fail.
This was (is) the right decision because:
- We learned how to control our money rather than allowing money to control us.
- We learned how to make money and how to make money work for us; e.g. we learned how to build sustainable wealth.
- We developed (and have maintained) key wealth building habits.
- I learned that there is no problem that cannot be solved and that my main task is to convert my predicaments into problems.
- Every time I remember that we paid off £100,000 worth of debt in three years, I blush with pride.
- Paying off our consumer debt is a great lesson to our sons: a lesson about money, honour and love.
- Paying off our debt was my redemption. My irresponsible, wasteful Self was sacrificed on the altar of consumerism to come out leaner, stronger and so much more present.
I don’t manipulate debt; I pay off debt.
Because by paying off debt, and killing it forever, I built myself into the woman I like and respect.
You should try this as well.
Get to know your debt intimately
I’m not going to tell you to become friends with your debt: this will be far too ‘new age’ for me.
Still, you do have to get to know your debt intimately if you are to pay off debt fast and in the least painful way.
These are the six question you need to answer so you could claim to be intimately acquainted with your debt.
Q1. How much debt do I have?
This may sound ridiculously simple; so much so that you may wonder why I am including it here.
Simple as it sounds, finding out exactly how much debt you have is not nearly as straight forward as you may think.
Would it surprise you to hear that I had absolutely no idea whether and how much debt we had? Neither did my husband. When he started ‘digging’ we found that we are in too much debt; so much, in fact, that I refer to it as ‘obscenely large amount’.
We are not uniquely inept at this; on any web forum about debt you will read the stories of people who thought their debt is much smaller than it actually is. Go read some.
Trust me on this one and save yourself, and your partner, a lot of grief: work out how much debt you have systematically and meticulously.
I’ll offer some ideas how to do this in the part on ‘debt mining’; so keep reading.
Q2. Who are my creditors?
This is very straightforward: you need to know whom you owe money.
It is still a time-consuming exercise and needs systematic approach. Make sure you don’t miss anyone from the list. Include the banks, the credit cards, your best friend and your parents. Oh, and your student loans and your store cards, and…
…well, you get the picture.
Having this information is very important for building your debt repayment strategy.
Q3. What is the rate of interest I’m paying?
Yep, you need to work this out for each and every debt you’ve identified.
In some cases, like credit cards, it is easy: you just need to open your credit card statement (or go on the card website) and read the small script. This should do it.
In other cases – like borrowing from friends and family – you’ll need to do some more digging.
Do it! This will help you develop a payment strategy, a plan and will motivate you to pay off your debt faster. Who wants to pay all this interest?
I felt really motivated to pay off debt faster after I realised the interest we pay keeps one lower level bank employee in wages for a year. How crazy is that, eh?
Q4. Which part of my debt am I paying?
Every time you make a debt payment you are paying two very different things:
- The debt itself (principal)
You’ll need to work out what proportion of your payment services the interest and what proportion actually reduces the debt.
You’ll find, that in most cases – and certainly when you pay only the minimum payment on credit cards – your payment is mostly interest and very little principal.
(Credit cards offering 0% interest are the exception but the payment is still calculated by the provider so that the offer ends before you’ve paid the debt off. Than you start paying high interest which is smart business and lousy debt management.)
Your aim, if you wish to pay off debt fast, is to get as quickly as possible to the ‘tipping point’ – the point where your payment pays off more principal than interest. This is usually when you have paid off half of your original debt.
Sprint to the middle and watch your debt crumble!
Q5. What proportion of my income goes on debt re-payment?
Many see this as a question about how much they are putting towards repaying their debt. I see it as a question about how much you have left to live on.
There is a life to be lived and fun to be had even when you are in debt.
Remember that this is about paying off your debt; it is not about having a date with the Spanish Inquisition!
Q6. How long would it take me to pay it all off?
This is easy: you know how much debt you have, how much you are paying off and the interest. The rest is simple arithmetic.
There are many debt calculators around.
I think the debt calculator on ‘This is Money’ wins ‘best in its class’ outright. Go, play around with it for a bit.
If it tells you that it will take you 150 years to pay off your debt, don’t panic.
Just use the second part of the calculator and see how much more you have to throw on your debt to pay it off fast (as fast as you wish).
(Note 1: I did mention that this post is long. It may be time to bookmark it and take a break.)
(Note 2: You can find detailed instructions on how to do your ‘debt mining’ and keep ‘debt records’ in the third post in the series.)
Paying off debt strategy
‘Strategy’ is a big word. You hear every day about ‘strategic thinking’, ‘business strategy’ or even a horse betting strategy.
Strategy doesn’t have to be big and scary; it simply means that you need to focus on the ‘long term’ in very specific ways.
To have a strategy you need to know where you want to be (have a goal) and use this goal as a compass that attracts all your actions.
Having a strategy is like playing chess. To win a game of chess you need to:
- Want to win;
- Master the rules of the game and use them to achieve your goal (win);
- Read carefully what your opponent is doing; and
- Ensure that you plan about twenty moves ahead.
I told you it is simple.
Now, let me tell you how this all is relevant to paying off debt fast.
I used to joke that my strategy to pay off debt fast was very simple: I spend no more than necessary, earned as much as possible and put the difference on the debt every time without fail.
This is true but our strategy was about much more than that. Our strategy to pay off debt fast used few of the tools in the arsenal for becoming debt free but I got to know about most of them.
Here is what you have at your disposal:
#1. Three ways to reduce interest
Your first priority when looking to develop a strategy for debt repayment is to reduce the interest on the debt. Why? Because lower interest means three things:
- It makes it easier to be able to afford paying off the debt on the same income;
- It means that higher proportion of your payment goes against principal; and
- Ultimately you pay less to pay off your debt.
In my case, for example, moving the debt from credit cards with between 20 and 26 per cent interest to a consolidated loan at 7% meant that we can afford payments. Otherwise we would have had to sell the house.
There are three ways to reduce the interest on your debt.
First, you can apply for 0% interest rate credit cards. Please pay attention to the following:
- The interest rate is not actually 0%, it is about 3% (or however much the transfer fee is);
- Make sure that you pay as much as you can off before the 0% deal expires. If you haven’t finished paying off your debt when this happens, make sure you have another 0% deal lined up.
Here is the bad news: if you have amassed considerable debt you are very likely not seen as a good risk; therefore you are probably unlikely to get a 0% interest rate credit card.
Between you and me, when we had just started paying off our debt I applied for one. I was refused. Now, I get 0% credit card offers through the door all the time.
The next best thing is to consolidate your debt. This simply means to take one large loan (usually secured against some of your property) instead of a number of credit cards.
Consolidating you debt into one large loan can save you a lot of interest. This is what we did: we took out a loan and used it to pay off all credit cards. This brought the level of interest from an average of 20% per year to slightly over 7%. I know this doesn’t look a lot but it has enormous effect because it not only saves you interest in the long run but also reduces the regular monthly payments from ‘an absolute killer’ to ‘doable with a bit of imagination’.
There is a lot to be said about consolidation loans.
On the positive:
- Taking out a consolidation loan saves interest: taking out a loan to consolidate many smaller debts usually saves rather a lot in interest payments.
- Taking out a consolidation loan ensures you are paying your debt down: loan repayments are calculated so that one always pays some of the principal rather than only interest. Keeping debt on credit cards always contains the risk that you will minimise the pain of changing your life and repayment by paying only the minimum amount. This is plainly dumb but at the same time it is a very successful business model for the credit card companies; which tells me that it is something many of us do most of the time.
- Taking out a consolidation loan means that you are not exposed to interest rate increases: the contract that sets out the conditions of the loan also state the interest rate; so it is very unlikely that you will get a letter informing you that the interest rate on your borrowing just went up 3%. This happens regularly with credit cards.
- Debt consolidation saves energy and bother: yep, I really mean this one. It would have really drained me to have had to deal with debt across nine different places. Having it all in one saved me loads of energy, worry and bother. It is really easy to follow progress as well – I have a lovely chart that keeps going down. I never thought that this could be so aesthetically pleasing – but I can admire it repeatedly.
On the negative:
- Taking out a loan usually entails collateral: what this means in simple terms is that because the bank wants to ensure you are going to pay back it asks you to put something down as security. Usually it is your home! This is a real problem if something goes wrong and you can’t pay back: if your debt is on credit cards the worst that could happen is that you will damage your credit rating, if it is a loan you could lose your home.
- You are stuck with the interest rate: most of the time this works in your favour. However, if your credit rating is good and your borrowing to income ratio is not atrocious there are 0% interest rates on credit cards. During the last two and a half years this has been often a point of regret for me: consolidating meant that we could not take advantage of these deals.
- Loans can stretch over a long period: in fact they usually do. Our loan is for ten years and I have to tell you that when we took it out I thought that this is the twilight of my life gone. Where we got it right is that we checked and double checked that there are no penalties for overpayment and early repayment; after that we attacked the loan with a vengeance and as a result we very quickly reached the point where the monthly repayment covered more principal than interest.
- Repaying a loan is a long term commitment: so is repaying credit card debt, you may think. Not the same! Keeping your debt on credit cards (and paying it down) is like running a number of sprints – each run is hard but there is a positive emotion at the end; so you can take a breath and go for the next sprint. Repaying a large loan is like running an ultra-marathon – you just have to keep going; and when your head is telling you to stop you just keep going! You can’t afford to ‘hit the wall’!
Where or not you use this option depends on the following:
- Can you take the collateral?
- Do you have a strategy for overpayment of the loan and have you checked that its conditions allow that?
- What kind of person are you? If you are a ‘sprinter’ stick with many smaller debts; if you have the mentality of a long distance runner consolidating is for you.
Last but not least, you can negotiate the interest on credit cards and private debts. My problem with this is that the outcome is uncertain and the creditor can bump it up again at any point (e.g. you have limited control).
#2. Off the shelf strategies for paying off debt
There are ‘tried and tested’ strategies to pay off debt. These are:
- Small to large: According to this strategy you order your debts from smallest to the largest one. Focus on paying the smallest debt first, than the next in order and…continue until all debt are paid off. This is a good route to take if need something extra to keep you motivation in top shape. There is are few things more motivating than seeing some success.
- Highest interest first: This strategy is about ordering your debt according to the interest these incur. Focus the paying off debt effort on the debt with the highest interest. Once this is gone tackle the next one. Don’t stop! This approach is supposed to save you interest but I remain to be convinced.
- Snowballing your debt: This is really cool and simple. It was pioneered by David Ramsey and state that you keep the amount you pay on your debt constant till it is all gone. Now, imagine you have three credit cards and pay £100 per month on each. When card one is paid, you don’t spend the £100 you don’t need to pay any longer on new clothes but add it to the payment of card number two. When this is paid off, you pay £300 per month off the last card. You see? It works like a snowball. Using it you’ll be able to speed up paying off debt.
- Snow-flaking debt: This is about putting any small amounts of money that you make or save against the debt. We used this one – every month I zeroed our budget. If there was £30 left, I threw it on the debt. Have I mentioned that our smallest payment was £4.35 (John did this) and the largest one was £8,348. This works but you have to develop the discipline and focus to put all ‘left over’ money on the debt.
- Race to the middle: This is the single most important thing for paying off debt fast and I figured it out at the beginning of 2010. The secret to paying off debt fast is to pay off half of your starting debt as fast as possible. We got there in 18 months (August 2011). This is the point at which your monthly payment starts paying more principal (the debt itself) than interest.
#3. What is your strategy to pay off debt?
This where things get a bit more complicated.
You can go with an ‘off the shelf’ strategy but it doesn’t mean it will work for you.
You strategy for paying off debt depends on your debt and your personal circumstances (see next sections of this post).
To be able to formulate the strategy for paying off debt that will work for you, you’ll have to answer these questions:
- Why do you want to pay off your debt? (Motivation is important and I had to remind myself all the time what this was about.)
- What is your time line? (Don’t be afraid to be ‘unrealistic’; I’d rather undershoot an ambitious goal than overachieve a very modest one.)
- What are the options best suited to your situation? (Are you going to consolidate? Snowball or snowflake? Etc.)
- How much per month you’ll have to pay to pay off your debt within your time line?
- What are the conditions for his to happen?
- Who do you need to talk to?
- Who may help you? What alliances you need to build?
- Who (what) may be in the way?
Now you are set. You have the goal, you have the motivation and you’ve done your thinking.
Write it down. Print it out and pin it where you can see it.
(This is because you will waver on the way. Trust me: I had so many wobblies that at one point I suspected I’ve morphed into jelly. Every time your motivation wavers, read why you want to be debt free and all will be well.)
It is time to make all that into a realistic plan.
How to make plans that work?
Okay. If your strategy is about answering the question ‘how do I get from where I am to where I want to be?’, your plan is the answer to the question ‘what do I have to do to get from where I am to where I want to be?.’
Also, the plan has to be very specific.
Plans that work share two characteristics:
- You develop them by planning from the future. Most people set their goals and develop their plans starting from where they are. This is obviously restrictive – if I started planning paying off debt from where I was, I would still be doing it. Start planning from where you want to be; work out the exact conditions (knowledge, skills, jobs, habits, alliances etc.) that will get you there and plan yearly, monthly weekly and daily the actions that will get you there.
- They are comfortable as a broken in shoe. Yes, good plans feel comfortable and they are flexible enough so that you can change them if you need to do so.
Does this sound like hard work? Do you feel confused about all these strategies and plans and all sorts?
Well, there is always Walt Disney if you do.
No, I’m not suggesting that you escape in the fantasy that Disney movies offer.
What I am suggesting is that you use what I call ‘Walt Disney’s Creativity Hack’ – it works when you plan how to pay off debt as well.
Walt Disney’s Hack
Walt Disney started his career as a journalist; and was told that he will never be creative enough to make a good one and sacked.
This only made him more determined to discover the ‘holy grail’ of creativity. Through observation and self-analysis he figured out that there are three sides to all of us: a dreamer, a realist and a critic. Normally these are in an ad hoc conversation dominated by the Critic. For example:
||‘I really want to become debt free in three years.’
||‘You know that this is rubbish and completely impossible. You need to pay over £3,000 per month to be able to do this. Now, there are dreams and there is delusion; and this, my friend, is a delusion if I have ever seen one. The money you need to pay off the debt every month to be able to pay it off in three years is exactly as much as your take home pay. What are you going to live on? So, you may as well forget it. ’
Conversation over; dream over. One more thing to mention at parties as an entry in my ‘Anthology of Selected Intentions’.
Clever Walt noticed this one and thought:
‘What would happen if the three sides talk in strict sequence: the dreamer goes first, after that the realist and only after that the critic is allow in?’
What happens is immensely powerful. Take a look at this:
||‘I really want to become debt free in three years. It would be lovely – the feeling of achievement, the freedom to do the things I won’t be able to afford for the next three years and the heady feeling coming with the knowledge that I’m completely in control of my money and my life. I won’t owe ‘nothing to nobody’ and my life will be mine to live. I can start building savings, investments and can even prepare an early retirement.’
||‘To do this you’ll need to learn a lot of stuff about debt, money, how to make choices, organisations that can help you…well, a lot of stuff. You have to come up with ways to decide what to do about your debt and distinguish between stretching goals and complete delusion. You can do this; you can learn. You’ll have to make sure that your budget is as tight as a little, black cocktail dress and it leaks from nowhere. You’ll have to look into options to increase you income. This has all been done before and if necessary you can go back to college or take some courses to learn. You have to make yourself act and do it fast. Still, this can be done. ’
||‘What can go wrong? Where are the holes in the plan? What can you do to either hedge against the risks (losing your job, for instance) or taking control?’
See the difference?
I’ve used this method a number of times and still use it when I’m at a turning point in my life.
Try it! What is there to lose? But remember:
- Your dream has to be very detailed; dream the colours, the smells, what does it feel like, who is with you. Detail is very important to develop the animal focus and desire that will carry you through the hard patches.
- Don’t let in the Realist and the Critic before you have finished dreaming. After that let them loose and transform this dream into a workable plan.
You remembered to write everything down, didn’t you?
If you did it, by now you have selected (developed) a strategy for paying off debt fast and have a detailed plan of what you are going to do so that your strategy works.
This is all for tonight. I’ll publish the second instalment next week.
Yep, what you are looking at is the expensive bottle of Cabernet Sauvignon that I brought back from Chile and it is empty; it was drunk last Friday and it was really great wine. Even greater was the occasion – we said that we will drink this wine, just the two of us, when we have paid off completely our consumer debt. Last Friday, February 1st, at 9.32 am John sent me a text simply saying ‘done and dusted’. And it said it all: we are debt free!
We paid off £100,000 ($157,000) worth of debt in three years…well, three years and three weeks to be exact. We probably could have paid it off five months earlier if we didn’t also do work on our house – during the last three years we have spent about £25,000 (about $40,000) on the house.
To do this we did sell only one thing: my car. Have to admit I did take it hard – this bright yellow Smart was so much me – but looking back it was a good move that we ought to have done even without being in debt. This was not a safe car to drive and we don’t need two cars anyway.
How did we do it? How to pay off debt?
Mostly by following the rules I have been telling you about in my posts under the Debt Movement (if you have missed them they are easy to find – just click on the category below the header of the blog). But here is a summary of what we did.
Most of our debt was on seven different credit cards and two of them from MBNA (ie BoA) had increased their interest substantially for no reason. Taking into account this and that managing so many cards may be a logistics nightmare and very time consuming we approached out bank for a consolidation loan. We had been with the bank for decades and are very good customers; after all during the first year of debt repayment we single handedly kept one junior employee in a job. Hence, our bank was very good to us in return and after a discussion with our personal bank manager we had a £80K ($126K) consolidation loan secured against the house and at 7.7% interest. On January 4, 2010 we had a loan to run for ten years and £20K ($31K) on credit cards and overdraft.
Ten years! Talking ultra-marathons; though at the time it felt to me more like a prison sentence.
Most people go through their lives not understanding what money is and how does it work. Some of them don’t even mind. I am not one of those – I believe that ignorance is an infliction and it has to be eradicated. This is why, one of the first things I did after the crisis had abided emotionally and rationality returned, was to start learning. I learned from websites and blogs, from self-help type books and from academic literature on finance and economics. We found that our lives were substantially over-insured with the wrong insurance, our house insurance was twice what it should be, car insurance could be trimmed and we checked all our utility bills. Most recently we realised that we had forgotten to check the water costs and found that by moving to a water meter, our water bill more than halved.
But we didn’t stop with the learning and knowledge; we did – we tried things, when they didn’t work we modified them and when this failed we thought of and developed completely different approaches. The Money Principle was to a degree a result of, and a platform for, this learning and experimentation.
Earned much more than we spent
This is a well-established mantra in personal finance and at one level is a very simple matter of first grade arithmetic. Where it gets exiting is when one starts thinking about how to do it.
We did it as a combination between rationalising our spending and increasing our income. For years, I lived under the impression that what we bring in regularly every month is not enough for us to live on (my salary and some passive income) – that we can’t survive without John’s consultancy pay. Since it as the fall off in consultancy that got us in trouble to begin with, I thought that we simply cannot make it.
When we looked at our spending it turned out that we can live on our regular monthly income even including the close to £1,000 ($1,577) monthly debt payments. We needed to change some things, true. We changed our insurance; I stopped having so many coffees and over-priced, nutritionally challenged meals at work; started cooking and eliminated waste. Hey presto! We could not only live on our regular income but also put £500 ($788) aside every month.
This meant that everything earned above our monthly income could go on debt repayments. When consultancy picked up again we used it all to pay the loan; when The Money Principle started making a bit of money – it all went on the loan. Gosh, even the £500 per month we were saving for rainy day went on the loan: paying this loan off was the rainy day. And in case you are wondering, we had such large accumulated historical losses in our company that the taxman didn’t get a bite! Well if we hadn’t had the losses, we wouldn’t have been in debt but that’s another story.
And it was so satisfying to see it go down!
You don’t have to be very observant to have noticed by now that the strategy was ‘throw everything at the loan’. But there was order in the debt busting frenzy and this came through realising two things.
First, no payment is too small to have an effect. Most people waste their lives waiting for the ‘big break’ – they wait for this big promotion, for the inspiration to write an award winning book and for the large windfall of money. But in all matters the old adage of long distance running training still applies: what makes you fit is not the seven miles you run on the weekend but the one mile you run every day. Translated this means that even large debt start crumbling when you make regular payments be it not so large ones.
The largest payment to the loan we made was the last one at £8,430 ($13,300); the smallest payment was £4.87 ($7.67).
Our second realisation was about the tipping point. When you start paying debt off – and for quite a long time after that – you pay much more interest than principal. Just as an example, on our £80K ($126K) loan during the first year we made 12 payments of £956 ($1,507) and in December the loan had reduced by £3,950 ($6,225) – the rest went on paying interest. To pay off debt fast one should race with all they have to reach fast the tipping point when they start paying more principal than interest – once there, the repayment stops being a Sisyphus task and the ‘stone rolls easily downhill’.
One of the best things we ever did was to set up our ‘so worth it’ fund early on. To remind you the rules, this is a sum of money (in our case £300/$473) that went in a separate account and was specifically designated for having fun; the condition is that this needs to be used completely every month. This fund kept us sane – having some fun in our lives made us focus more completely and calmly on the rest of what we had to do.
During the last three years we went skiing and spend time in the sun (we used our apartment in Sofia as a base so we could get good price); we had expensive haircuts and chased marathons. We felt happy and positive!
A bit of luck
In this kind of mammoth task a bit of luck is always welcome. In our case it came as a substantial payment from MBNA (the Ombudsman judged in our favour) and a bit of backdated payment of child benefit (altogether about £13,000/$20,500).
…I don’t have to tell you that John and I feel ecstatic to be debt free; I am not sure whether I have ever felt as proud of myself as I feel today. Because from now on we can start building wealth seriously, consistently and without the pressure paying off debt.