CFO of Life #80: Couples vs. Debt: How to conquer debt in 5 Easy Steps

Debt is one of the most uncomfortable topics, period!

It doesn't matter if it is personal loans, mortgages, student loans, jointly owned, company, government or any other debt, no one likes to talk about it! And that is why debt can become such a burden. Unsurprisingly, there is a lot of information on what to do with your debt or your company’s loans.

But if you open YouTube and search for “how couples should deal with debt” you get a lot of talk shows and podcasts where people complain about their debt. And most of the time that is extremely counterproductive and underproductive.

But you know me, I do my best to cover all things money and help you learn more about personal finance.?

This week, we will look at the 5-step plan for couples to master their debt. It focuses on fostering and building a healthy relationship with the topic and gaining an in-depth view of how to resolve any problem that occurs.

To do so, we need to start with getting some things straight and build up our basic understanding of debt.

Step 0. Debt 101 - everything you need to know about debt in less than 200 words

Step 0.1) What is Debt?

Debt is owed money, requiring repayment with interest in a specified time in the future.

Step 0.2) What are the elements of Debt?

There are five components to debt. They are quite straightforward, but it is good to make sure that we all start from the beginning and build up.

Principle - The total amount you take out, ie. the money you receive

Interest rate/ APR - The percentage of interest charged on a monthly/ yearly basis

Payment - Your monthly payment amount

Total cost - The total amount you repay for the loan

Duration - The period you have to repay the loan

Step 0.3) Types of Debt - Good vs. Bad

Good Debt is the one that helps you grow and adds value to your life. Here you can add things like student loans, mortgages or any bonds you own as they bring you money instead of costing you some.

Bad Debt is the one that costs you more than it should. A prime example of that is credit cards which could easily charge you 20-50% interest per year. This is not only damaging because it would cost you crazy amounts of money, but because it would also push you towards buying things you don’t need!

Now that we have the fundamental knowledge about debt set, it is time to move towards the 5-step plan that couples should use to master their finances.

Step 1. Communication - how to be open and honest when talking about debt

Discussing debt with your partner is extremely hard and I have first-hand experience doing so. Luckily, we have never found ourselves in a hard situation so the topic hasn't become a taboo.

Step1.1 13 questions that each couple needs to go through when it comes to debt:

1. Should we set any ground rules for taking on new debt together?
2. Does dealing with debt cause stress in our relationship?
3. What if one of us feels discouraged about managing our debt?
4. What are our long-term financial goals, considering our debt?
5. How can we maintain a positive outlook while working towards becoming debt-free?
6. How can we ensure we're on the same page about our risk tolerance when it comes to debt?
7. How can we hold each other accountable for sticking to our debt repayment plan?
8. Are there any debts we should prioritize paying off first?
9. How will we handle unexpected expenses that add to our debt?
10. How comfortable are we with using credit cards in the future?
11. Do we need to adjust our budget to tackle our debt more effectively?
12. Are there any financial mistakes we've made related to debt that we can learn from?
13. How can we celebrate our progress in paying off debt together?

Step 1.2 Be vulnerable and talk about it

Now that you have those 13 questions, it is time to go through them with your partner. Be vulnerable, talk about each point, take your time and don’t rush! The two of you should get on the same page and should be able to openly talk about debt and your current situation.

Step 2. Review - How does your Income stack against your Debt

Now that you can talk about debt, it is time to see how it stacks against your income.

Step 2.1? List all of your debts and their interest rates

Now that I have you talking, it is time to lay your cards on the table. List all your loans and look at where you are, how much you own, how much time you have to repay it and when. This is one small step, but it would help you make huge progress in your relationship.

Step 2.2 Debt repayments as % of your income

It is extremely important to know what percentage of your income goes towards debt repayment. Knowing that will help you understand not only where your money goes, but how much you are wasting by paying for interest on those loans!

To calculate this, take all of your debt repayments for a month and divide them by your combined income and you will have the % of your income that goes towards paying off your debts. If you have $200 in debt repayments a month and a combined income of $1,000, then you spend 20% of your income to cover your debt. If the 20% covers your mortgage, then you are doing quite well! But if your debt is edging towards 40% or more, then you have a serious problem at hand as you are spending so much to repay your debt, you will have no money left. Even if that includes your mortgage, don’t forget that banks start getting worried about your ability to repay your loan once it reaches more than 45% of your income.

Step 2.3 How many years would it take you to “pay it all off”

Now that you know the total value of your loans and how much of your income it takes to cover them, it is time to understand how many years it would take your debt. The quick and dirty way is to look up how long your longest loan is and that would be when your “debt nightmare” would end. But to get a more “scientific answer” you need a more calculated way to approach this, all of that is covered in step 3

Step 3. Resolve - The two most popular ways to resolve your debt

In general, there are two well-established methods to deal with debt: the avalanche or the snowball method.

The Avalanche method:

This approach is really simple, cover the minimum payment on all your debt and pay as much as you can towards the highest APR loan. That would result in you not incurring any penalties as you pay all minimum fees. Meanwhile, you will be reducing the higher interest rate loan so you will minimise the amount of interest you pay.?

The Snowball method :

This approach is somehow similar to the avalanche, but instead of focusing on the maximum APR, it focuses on paying off the smallest debt first and working your way towards the biggest debt. The rationale is that closing the smaller loan will prevent the accumulation of any interest on it. Furthermore, once you close one loan, you will have more money to contribute towards the next loan which would give you more money for the next one and that is where the name “Snowball” comes from. You can find a detailed example of how those methods work and the maths behind them in the comments.

Step 4. Consider - Evaluating if any new debt is worth it!

Now that you are on the path towards clearing out your debt, you must become a lot more deliberate when it comes to taking up new debt.?

To do so, you should put it through the lens of those two questions: Do we need it and Can we afford it?

Step 4.1 - Do we need it?

This is the lens of a sanity check that would ensure that you are not just trying to keep up with the Kardashians. Is it simply something you want because of lifestyle inflation, then you might not need it. (my A to Z guide on how to beat lifestyle inflation)

Step 4.2 - Can we afford it??

On the other hand, if you have a good reason why you need and want it, then you should check if you can afford it. And the simplest way to do so is by measuring how much more % of your income you would need to spend to cover this debt. As this is your life and it is extremely complex and individual, I can’t give you blanket advice. In general, you should try not to pay more than 35-40% of your income towards covering your debt. Anything below that is a good amount, but don’t just try and game the numbers, use your head wisely.

Step 5. Resolving - Understanding why paying off your debt is a good thing

Just imagine not owing money to anyone, not being chased for any repayment and having all your income available to do whatever you want with it. Does that not make you excited? If not, here are 5 more reasons to do so! Peace of Mind: Debt could be a huge burden and knowing that you owe money to no one is a huge relief!?

Financial Freedom: If you pay all your debt, you will have a lot more money available to spend on the things you have and have no looming payments waiting for you around the corner.

Better Credit Score: Having and poorly managing debt would significantly impact your credit score. But paying off your debt will slowly repair and improve your credit score, which in the long run will make your next debt a lot more accessible with significantly better terms. Creating great habits: Paying off all your debt on time will not only get you in better financial shape but will also help you build great habits. It would ensure that you are vigilant with your money and mindful of your purchases.

Flexibility: Last but not least, when you have no debt, you have no limits on what you can do. You are the master of your income and no central bank can lift the interest rates and make your mortgage double overnight and cause you to panic and lose your sleep.

Hopefully, all of this would serve as a great guide on how you and your partner should go about managing your debt, which is not an easy thing to do. But this 5-step program would act as a structure for the two of you to use when having those conversations. It would help you understand what is next and how to prepare for it.?

But beware, this is no easy topic and you might have a disagreement or two about it, which is normal. Just be respectful to each other, make sure you give yourself space, communicate all the things you need and take time when it is needed.

Next week, we will look at how to build an all-encompassing plan for a couple and how to review, manage and win over your financial goals!?

Thank you for reading! All comments and topic suggestions are highly appreciated. Post #80 in the series CFO of Life #si #personalfinance #CFOofLife