CFO of Life #127: Debt and how to deal with it!

Imagine a life where your paycheck isn't swallowed by debt.

While today you might only think this is impossible, I can guarantee you that a debt-free future is entirely plausible.

All you need to do is pick a path, be consistent, track your debt, create a debt solution plan and stick to it. And if you keep to your plan, you will get there quickly and easily.?

That is why, this week I want to focus on helping you understand debt a bit more. So you can start building your strategy towards eradicating your debt and living a life that is a lot more free and happy!

To do so, we would need to focus on those four points:

1.? What are the elements of debt?

2. Which element of debt makes it hard to deal with?

3. What are the most common strategies to deal with debt?

4. Snowball vs. Avalanche: Choosing Your Debt Demolition Method

?If this is your first time reading this blog, my name is Simeon Ivanov (Si-Me-On). I write this weekly blog about personal finance called CFO of Life to bring you on your journey to becoming the CFO of your Life! I hope you like it and stick around for the long term!

Five components make debt what it is. And while they are all straightforward, it is always good to create great foundations to build on.

* Principle – The value of your loan or the amount of money received.

* Interest rate / APR – The percentage of interest charged to your loan on a monthly/yearly basis.?

* Payment – The amount of money you pay on each deposit.

* Total Cost – The total amount you repay for the loan through its duration.

* Duration – The period of time you have to repay the loan.

While the five elements are straightforward and easy to understand, two are extremely important to master. Unsurprisingly, they are well-interlinked and heavily influenced by one another.

Those two elements are the interest rate and the total cost of the loan.

You see, the interest rate will directly impact how much you pay each month and how much you pay through the loan term.?

In a situation where your interest is high, it can easily double or triple the value of your loan as it can compound quite quickly. At the same time, if your interest rate is low, you will not accumulate a significant increase in your loan.

As you can see, the interest is directly connected to the total cost of the loan. You can think of them as air and balloon. The more air you put in the balloon, the bigger it grows and the more air you need to remove to release it.

The idea is that the two are interconnected, and when one goes up, the other goes up. At the same time, if one goes down, the other one goes down. I know that is a super simple way to present it, but understanding the relationship between the two is extremely important. There are countless examples of people taking a small loan with a huge APR and quickly needing to pay 2-3 times the loan amount.

Another good example is your credit card, which would probably have 25-30% interest rate. That by itself would double the amount you owe every 3 years! Just imagine forgetting to pay a $300 bill; in 3 years, you would need to pay $1,000. That by itself can be a huge surprise!?

Dealing with debt is not easy; it can take a lot of time, and you can do many things to make that journey easier. I will tell you the 3 strategies you can use to deal with your debt.?

Strategy 1 - Budgeting and managing your expenses:

This is the cornerstone of any debt repayment plan. If you meticulously track your expenses, you will find areas where you can cut back and free some funds. Those funds will help you increase the amount you can repay each month, and that will help you get rid of your debt a lot quicker!

Strategy 2 - Debt Prioritization:

When you have more than one debt, it is really important to find a way to prioritise them and repay them one by one. To do so, you can take one of the two roads.

You can use the Snowball Method, which focuses on paying off the smallest debt, then the next smallest, and that way to the largest debt. Or you can use the Avalanche Approach, which takes the debt with the highest interest and aims to pay it off first.

Strategy 3 - Debt Consolidation:

Another way to deal with debt is by combining all your debts in one place. While this is a great idea, it might be hard to execute in practice, but if you do, it can quickly decrease the overall costs of your debt. But all this depends on your debt type and how big it is, as those are the two decisive factors determining whether you can consolidate it.

Debt can feel overwhelming, but tackling it with the right strategy is key to eliminating it. As mentioned, the Snowball and the Avalanche approach are the two most popular debt reduction methods. One focuses on quick wins and providing easily visible results, while the other focuses on reducing the overall amount you pay by lowering your interest.

Now, to find the best for you and your situation, let's dive into them in more detail.

The Snowball Method - Piling up Small Wins for a Big Momentum

How it works:

1. You would need to list all your debts from smallest to largest by the amount you owe on them.

2. start making minimum payments to all debts, but the smallest one.

3. Put all the extra money you can in the smallest debt until it is paid off.

4. Once that is done, roll the payment into the next smallest loan and continue doing that until you repay all your debt.

5. Repeat the process until your “snowball” becomes big enough, and you repay all your loans!

Pros of the method:

Psychologically, you will see early results that can help you boost your motivation.

The simplicity of the method makes it easy and straightforward to understand and implement.

Cons of the method:

It ignores the interest you will pay on each loan, which might cost you more in the long run. That would also increase the time you have to repay all your loans.

The Avalanche Method - Strategic Savings For Efficient Elimination

How it works:

1. List all your debts from the highest interest to the lowest interest, regardless of the balance.

2. Start making minimum payments on all debt except the one with the highest interest rate.

3. Ensure you add all your funds to eliminate the highest-interest rate loan(s) first.

4. Once the highest interest rate loan is gone, continue with the next highest interest loan.

5. Rince and repeat from steps 1 to 4 until you are debt-free!

Pros of the method:

This methodology will save you the most money by reducing the amount of interest you pay.

Due to paying a lot less interest, this is mathematically the quickest way to become debt-free!

Cons of the method:

Psychologically, seeing progress might take time, especially if you have large high-interest debts.

This approach requires considerable discipline and consistent effort and is unsuitable for people who like immediate gratification.

Last but not least, if you are not organised and always on top of your calculations, it would be hard to stick with this method!

Ultimately, the goal is to become debt-free, so you need to choose an approach that works for you and your financial situation and that you can keep up for the long term.?

Regardless of how you go, any method would work, as long as you are consistent. Consistency is the key to achieving anything and everything, especially in finance. At the same time, it is extremely important to ensure that you don’t have any unnecessary expenses that slow you down and do your best to increase your income.

While the best thing is to have no loans that drag you down, in some situations, this is inevitable. And if you are in that situation, the best time to take action was yesterday, but the second best time to do something is no!And I know it is super hard to build a plan for dealing with your debt, so next week I will help you make a plan from A to Z on dealing with any debt!

Post #127 in the series CFO of Life #si #personalfinance #CFOofLife