Eliminating debt

Your first goal while trying to improve your economy should be to eliminate expensive debt. High-interest debt can cost you a lot of money and have a negative effect on your net worth. All money that you pay in interest is money that you could be saving or investing. Once invested, this money could earn you more money.

A lowered net worth and less money to invest is not the only negative effect of debt. In the short run, it is not even the most negative effect of debt. The most dangerous effect of debt is the damage it does to your cash flow. The money you need to pay to your debtor each money is money you otherwise could spend on other things. The cost of the loans can make it difficult to make sure you got money until the next paycheck arrives. You might be forced to take new loans that you would not need if you didn’t already have debt. Expensive debt can quickly become a negative spiral, and some more predatory loan companies, such as some payday loan companies, expect you to fail to make your payments. They expect you to be forced to take new loans. This will turn you into a loyal, profitable customer for the payday lender.

Your first goal should be to lower the effect your debt has on your cash flow. Once you have improved your cash flow, you can look to eliminate your debt altogether.

eliminating debt

Unify all loans

Small loans are expensive. Larger loans are a lot cheaper. This is due to the fact that the administrative costs remain approximately the same for all consumer loans. This allows you to save money and improve your cash flow by taking out one big loan to pay off all smaller loans. Many lenders offer this type of loan. They might be willing to give you a loan even if you already have a lot of debt due to the fact that they know that the loan will be used to eliminate old debt.

Calculate how much it would cost to completely pay off all your high-interest rate loans (mortgages are not included) and then contact a suitable lender to see if they are willing to lend you the money. Converting small loans into one big loan has several benefits.

  • Lower interest rate: You will usually get a significantly lower interest rate if you convert your debt into one single loan. You will often save hundreds or even thousands a year.
  • Smaller monthly payment: One single loan can be repaid over a longer period of time than many small loans. You can often choose to repay the loan in 5-10 years. This is a lot longer than most smaller credits. You can often cut your monthly payment in half or more by converting all your debt into one loan.
  • Easier administration: It is a lot easier to keep track of and make one payment a month than it is to make sure to remember a lot of different payments.
  • Easier to repay early. You do not have to consider which debt to pay off early. You simply make extra payments on one single loan.

Converting your debt into one single larger loan will improve both your cash flow and your future net worth.

Repaying your loans

From here on, we will assume that you were unable to convert your loans into one big loan. If you did convert loans, then it is very easy to repay your loan. Simply use any extra money you got to make an extra payment on your debt.

Knowing the best way to pay off your debt is a lot harder if you still have a lot of smaller loans. If you have a lot of small loans, then you have to consider when to pay extra on which loan.

The most important rule when repaying your debt is the NEVER spread money over several different loans. Always focus on one loan at a time. Make an extra payment on that loan every time you have extra money. Keep focusing on that single loan until it is paid in full. Then and only then can you start paying extra on another loan. Focusing on one loan at the time will give you the best results and allow you to fully eliminate a monthly payment faster. Spreading the extra payment over all loans will have a smaller impact on your monthly payments.

There is no exception to this rule. Always focus on one loan at a time. The question is which loans you should focus on first. To determine this, you need to make a list of all your loans, how much is left to pay and the interest rate of each loan. Also, include any monthly administrative fee that the lender might charge you to send the bill. Once you have this information, you are ready to determine which loan to focus on first. ‘

There are two main techniques that can be used to decide which loan to focus on. One method focuses on efficiency, the other on motivation.

Efficient method

This method focuses completely on making sure that you pay off your loans in the most efficient way possible. This method assures that you become debt free as quickly and cheaply as possible. If you want to use this method, then you should arrange all your debts in order of cost. Place the loan with the highest interest rates (administrative fees included) on top of the list and then continue down the list until you have sorted all loans according to cost.

Please note that the cost is not the monthly payment. It is the interest rate plus administrative fees. A US500 loan with a 20%APR is more expensive than a 100 000 loan with a 10%APR even if the monthly payment is larger for the larger loan.

Once you have your list, you should start by paying off the most expensive loan, regardless of size. Start paying on the second most expensive loan once the most expensive loan is eliminated. Every time a loan is eliminated, your monthly expenses will become lower. I recommend that you use all the money you free up to pay off the other debt quicker. Avoid using this money for anything else until you have paid off all your debt.

This method is the best method to use, but it can be hard to stay motivated if the most expensive loan is a large loan.

Motivating Method.

The motivating method focuses on allowing you to see quick results. This will keep you more motivated and might make you more likely to succeed in eliminating your debt even if you will spend more money doing so than you would use if you use the most efficient method.

If you want to use the motivating method, then you sort all your loans in order of size. You start by focusing on paying off the smallest loan. This allows you to eliminate one debt as quickly as possible. It allows you to see quick results. Once the first loan is eliminated, you move on to the second largest loan.

This method is less efficient than the method above, and it takes more time to become debt free. This method is despite that often the best because more people stay motivated and eliminate their debt using this method.

Use the method you think will work best for you,

The hybrid Method

A good compromise can sometimes be to use the hybrid method. This method focuses on motivation and efficiency. You will need to make two list.

  • One where you list your debt according to size
  • One where you sort it according to cost.

Start by paying off the smallest loan to get a quick win. Once the smallest loan is paid off, move over to the other list and start paying off the most expensive loan to be more efficient. Once the most expensive loan is paid in full, you move your focus to the smallest remaining loan. You jump between the two lists like this until all loans are repaid in full.