At some point in your life you will probably have some form of debt. It may be student loans, mortgage, line of credit (LoC), or God forbid credit card debt. However, if debt is used responsibly it can be a great tool to further your financial situation. Below we look at how you can control your debt rather than have it control you.
“The decision to go into debt alters the course condition of your life. You no longer own it. You are owned.”
Dave Ramsey
The beginning of 2019 saw a slight decrease in household debt compared to Canadians disposable income. Sounds like great news. However, this was not due to a reduction in debt but rather an increase in disposable income.
In the first quarter of 2019 household debt compared to disposable income was 173%. This means that households had 1.73 times as much debt as disposable income.
For example, if your household had $35,000 of disposable income, it probably has $60,550.
What is Disposable Income?
According to Investopedia; “Disposable income, also known as disposable personal income (DPI), is the amount of money that households have available for spending and saving after income taxes have been accounted for. Disposable personal income is often monitored as one of the many key economic indicators used to gauge the overall state of the economy.”
What is household debt?
According to Wikipedia household debt is defined as; “the combined debt of all people in a household. It includes consumer debt and mortgage loans.”
How to control debt
There are many effective ways to control debt, and different strategies work for different people. A large part of financial success is psychological habits and a persons view of money. Below is a list of financial habits and tips to implement in your life.
- Figure out how much you owe and the terms
- Figure out Cash Flow/budget
- Make a payment plan
- Figure out your $0 balance day
- Talk about it frequently
How Much Do You Owe?
When talking to people it is surprising how many of them do not know how much debt they currently have. In today’s society debt has become so normalized people seem to forget its pitfalls.
How many times have you heard someone say they hate looking at their bills? Maybe you or someone you know doesn’t even open the bills because “there’s no point! I can’t afford them anyways”.
The first step in being in control of your debt, is to know exactly how much you owe and to whom it is due. One of the best ways to track this is with a spreadsheet. Have the following columns: $ amount; interest rate; lender; and, payment due date.
Cash Flow/Budget
Once you know much you owe and to whom it is due, its time to sit down and crunch some numbers. Figure out how much money you have coming in every month, and where it is all going. Maybe you have $100 of unallocated funds or maybe $1,500.
Unallocated funds doesn’t mean just money that wasn’t spent at the end of the month. You have heard us say before “save first, then spend”. Part of saving first also means paying your debts.
Doing a cash flow analysis will help you determine where you need to focus your monthly cash flow and where you can cut back spending. This may sound like a big task but if you can stay diligent and sit down once a week, you can cut the time commitment down to around 15 min.
Payment Plan
Once you know how much money is available each month, its time to start making a payment plan.
There are several varying opinions on which debts should be paid first. Some suggest paying off the largest debts primarily, others say we should focus on smaller debts. We would suggest paying off the smallest debts first, as they generally charge the most interest. However, it really comes down to the debts with the highest interest rate. Pay those down first!
Depending on the type of debt you carry, your payment plan can vary. The first step is to gather all the information on each outstanding debt. Lenders do not want you to default on your debt. If you default, lenders often only recover a fraction of the amount you owe them. That being said, they are often willing to work with you to restructure payments or terms to ensure you pay off your debt.
Sometimes by calling a lender you can lengthen the terms of the payments or decrease the monthly payment amounts.
After calling the lenders, the next step is to decide which debt you will pay off first or if there is a way to consolidate your debts into a larger, lower interest debt.
For example, if you have 3 credit cards (CC’s) where you owe $5,000 on each it might be better to consolidate. CC’s often charge interest between 15% – 21%. However, if you can get a line of credit (LoC), which often charge 5%-9%, not only are you decreasing interest payments and saving money, you are also decreasing the number of debts you have to keep track of.
Furthermore, if you can automate all of your payments it will be so much easier for you.
$0 Balance Day
Once you have a payment plan in place, figure out when you will be debt free. For example if you payment plan is to pay off $300 of debt every month, how many months will it take you for that debt to be gone. It might be 12 months or it might be 12 years.
Obviously the quicker you can do it the less interest you will have to pay. However, just having the payment plan and $0 balance day in mind has put you way ahead of where you were.
Having this goal defined will help you see the bigger picture and keep you motivated. Psychologically, it is a lot easier to do something if you have your goal set to work towards.
Talk About it Frequently
Once you have a plan in place make sure it doesn’t slip through the cracks. No matter if you are single or have a significant other, sit down once a month just for 20-30 minutes and discuss your finances.
Talk about your financial goals for the next month and review your budget/cash flow. Look at the debt balances remaining and celebrate the fact that they are lower, even if it is only marginal.
You don’t have to sit down for 3+ hours and address all of your debt problems and solve them in one session. That is when it becomes daunting and unbearable. Wars aren’t won in a day, and you won’t master your personal finances in a day either.
Once a year sit down and have an annual review. Celebrate the victories and look at areas that could use improvement. Review your long-term financial goals and goals you have for the next year. Breaking these “meetings” into bite size pieces will help keep you focused and motivated.
If your looking for more tips on talking about money read; The Importance of Talking Money.
Maybe you’re in a particularly tough situation and you don’t know where to start? Fill out our contact form and give us some brief details and we will get back to you as quick as possible!
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Disclaimer: This Forbes Wealth Blog is for informational purposes only and does not constitute financial, legal, or tax advice of any kind. Please consult your legal, accounting, tax, investment, banking, and life insurance professionals to get precise advice relating to your particular situation before acting upon any strategy
