In the past, I have written about treating your personal finances like a business. Good personal financial health helps lay the foundation for good financial health in your business.
Today I wanted to share three options you can implement today to start paying down debt and three options that can help you increase your income and even save 50% of it!
3 Strategies to Decrease Debt
1. Pay Extra on the Debt with the Highest Interest Rate
This method disregards balances and focuses on saving the most money solely based on interest rate. It works well if your balances and loan terms (length of time required to repay) are all relatively similar, but is not as effective when comparing the amount of interest owed on loans of differing term length and a much larger balance. However, if you have a high interest rate above 10% as is common in credit card debt, then this is the strategy for you.
Example) $140,000 mortgage at 4.4% for 30 years vs. $40,000 credit card debt at 12.4% for 10 years.
You would pay an additional $184,800 in interest on top of the $140,000 mortgage or $324,800 total.
On the credit card you would pay an additional $49,600 in interest on top of the $40,000 for a grand total of $89,600.
If these figures come as a shock to you, I encourage you to write down your loan terms and interest rates. WebMath.com has a simple interest calculator that your can use to see your total interest paid.
2. Apply the “Debt Snowball” Method
Made popular by financial guru Dave Ramsey, this method is a practical if somewhat more psychological strategy. The debt snowball method is basically choosing the debt with the lowest total balance and focusing all your extra money on paying it down first while only paying minimum balances on the others.
Then once the smallest sum is paid off, you take money you were paying towards the first debt and add it to the payment for the loan with the second lowest balance. This method will disregard interest rates, term and type of debt. It is a great method for the “unmotivated” debt-owner because it uses small “wins” to develop good financial habits.
Example) Debt A is $14,000 and the minimum payment is $340/month. Debt B is $26,000 and the minimum payment is $400/month. Let’s say you have an extra $500/month you want to commit to paying down your debt. You will apply it to the $340 payment to equal $840/month on Debt A. The key is as soon as you pay off Debt A, you then take that $840 and begin applying it immediately to Debt B. So your payment towards Debt B becomes $400/month + $840 for total payment of $1240/month. You continue using this method to “snowball” your payments and pay off debt quicker and quicker.
It is a great motivator to get you started on becoming a good steward of your money. This is a great strategy if your debt feels overwhelming and you don’t know where to begin. A good debt snowball calculator like the one at Financial Mentor can help you get started.
3. Use the Lowest Cash Flow Index Ratio Strategy
The first time I ever heard this one explained, I thought to myself, “That makes a ton of sense for an entrepreneur!” Basically using this method you would divide your total payoff balance by your minimum monthly payment.
Example) $17,000 total remaining balance/$523 min monthly payment = ~32%
$95,000 total remaining balance/$965 min monthly payment = ~98%
$81,000 total remaining balance/$500 min monthly payment = ~162%
$24,000 total remaining balance/$350 min monthly payment = ~68%
Using this method, the lower the number, the faster you should pay off the debt. A ratio under 50 equals poor cash flow, 50-100 is in the caution zone and more than 100 is the most efficient in terms of cash flow index. The idea behind this method is to free up cash in order to invest in other opportunities, not in order to accumulate more debt. Many businesses use this method in order to free up cash.
Whether you choose one or a combination of all three of these options, it is important to have a financial plan in place. At the very least, do some of these quick interest calculations so you can see exactly how much you are spending on interest each day, month and year.
Now that you have a few ideas for decreasing your debt, lets talk about how to optimize and multiply your existing income!
In Part 2, learn how to save 50% of your income in 2016.
Financial Freedom is within your reach!
Join me on this exciting new journey to financial freedom and entrepreneurship!