Step 3 to Wealth: Paying Off Debt

Once you have a budget in place you’re off to a good start at becoming wealthy. Normal people would go through life as you are now, work until they’re 65 or so, and then retire to a life of semi-luxury (which is just fine). But you want more. You want to be super-human. You want to be wealthy! After you’ve been living with and adjusting to your budget for a while, you’ll have an “emergency fund” category setup to cover unexpected expenses like job loss and a broken down car. If you’re to become wealthy, next you’ll need to invest.

debt-noA basic outline of becoming wealthy looks like this.

  1. Follow a budget
  2. Build an emergency fund
  3. Pay off debts
  4. Invest

Don’t know anything about investing? No problem. Here’s lesson one. If you owe any money on any credit card, anywhere, no matter the interest rate, then paying off that credit card is the best possible investment for you. It’s quite simple really – whatever the interest rate is on the debt you owe is the guaranteed rate of return on your investment for paying it off.

snowball-1Hands down the best way to start paying off your debts is to use the “debt snowball” technique. It starts by using the extra money you’ve been putting into the emergency fund. Follow these simple steps.

  1. Order your debts from the lowest to highest balance.
  2. Make minimum payments on all of your debts, except the one with the lowest balance.
  3. Use the money that was going towards your emergency fund to pay down the lowest balance first.
  4. When the lowest debt is paid off, the entire amount that was being paid towards it is used for paying off the next lowest debt.
  5. Repeat starting at step 2.

Here’s an example. Lets say you have the following debts.

Creditor Amount Owed Minimum Payment
Store Mart Credit Card $500 $43
Top College Student Loan $6,000 $119
Fancy Flights Credit Card $7,000 $150

Extra emergency fund money: $100 / month.

So your total debt is $13,500 and you’re paying at least $312 per month towards these debts. You pay the minimum on everything except the Store Mart Credit Card – you put the extra $100/month towards that. In 5 months when that’s paid off, you add the entire $143 payment to paying down the Top College Student Loan to make your monthly payments $262 towards that debt. When that’s paid off, you make $412 payments to the Fancy Flights Credit Card until it’s paid off. In this example we’ve saved $5,000 in interest and paid off our debts 62 months (5 years) earlier than making the minimum payments.

The best thing about this technique is that it feels good because you can see that it has an immediate effect. Yes, managing your money can feel good. :) Try it here!

Leave a comment

Your email address will not be published. Required fields are marked *