By Mattijn Franssen
Be Ruthless with Debt
The third principle I learned was to rid myself of debt. There are benefits to this principle beyond just the financial savings.
If you missed lessons one and two click here
Once you have eliminated debt from your life you are free. You do not have the requirement hanging over your head that tells you every month you must pay this bill, you must not lose your job or you won’t be able to pay this bill, you can’t spend money on things you enjoy because you must must must pay this bill. Every little thing we have to think about weighs us down. You may have the perfect little system where you organize all your bills by date due, set them up for payment in your online banking but your subconcisous is still thinking and worrying about them, especially the debt. You have made yourself a slave to the man, you work because you have to .
When I was younger, we spent almost half of our income on debt payments; including the mortgage, two car payments, student loan, home equity loan and credit cards. That left around half of our money to pay taxes, insurance, food…and usually nothing left for savings or fun.
Now, having been ruthless with our debt and putting as much money as we could to paying it off, we freed all that money to be used elsewhere. My current debt to income ratio is around 6%. I only owe on my home mortgage and hope to have that paid off in a few years.
My goal is to retire completely debt-free where I only have to pay for my living expenses.
Think about the numbers for a moment. If you are making $60,000 per year and you’re currently spending 50% of that on debt, that is $30,000 or $2,500 per month. How would you like to have that extra money around to save for your retirement or enjoy life a little more?
The average American has over $200,000 in debt. That is just the average and it is easy to be blase about it, but look at that number. That is what the average person owes, how many of them would rather have that in their savings account than weighing them down?
What is a good debt to income ratio?
If you’re over 43%, you need financial help and you should do so today. If you’re 36% or less you are doing ok.
So how do I start reducing my debt?
The start is to spend less than you make. By doing this you have money left over to save or spend wisely, in this case to use it to pay down debt. Treat your own life as if it is a business. How long could you stay in business if you spent more than you made? Not long.
Here’s some things I have learned:
1. Don’t buy too big a house. Most people spend too much money on their home. You read that you can spend 30-35% of your income on your home. Try and keep that closer to 20-25%. Stay in your apartment or small home long enough to save more money. Think about all the sacrifices you would make to buy that bigger home. Also think about commuting time. The closer you live towards your work, the less you spend on gas and fewer miles you put on your car.
2. Put at least 10% of your money aside to pay down debt. Most credit cards charge interest rates of 18-20% or more. You can’t get much better returns on your money than that.
3. Buy used cars that are low mileage, and 1-3 years old. Either pay cash for it or accelerate the payments so it is paid off in 1-2 years and then continue saving that money towards future repairs and purchasing your next vehicle. You want to keep your total debt less than 36%, so if your home is 25% of your income that only leaves 11% left for your remaining debt. The other rule of thumb is to take your gross salary and multiply it by 20%. So if you make $60,000 per year, you can buy a $12,000 car. This will keep your loan payments low.
4. Have your kids go to a local junior college for their first two years and then transfer to a college where they can finish their degree. Opt for one that offers a full to partial scholarship, or is also local to save on room and board.
5. Use a sensible, easy-to-follow budget that keeps your spending in line. Spend less than you make, far less so that you can also save money and pay off all debt. Keep doing this even when you start to make more money. Forget the Jones’ – they are in debt up to their ears. Figure to use at least 10% of your income to pay down debt. The more the better.
6. Read good financial books and subscribe to informative financial blogs and podcasts.
7. List out all of the large ticket items that you want or need over the next 5-7 years. You probably won’t be able to afford all of them, so prioritize them by “must pay” like a new roof, and “like to have” such as an African safari. How much money is leftover after saving for the “must pays”? If anything, use it to save for your most important items so you’ll have the money when the time comes and you won’t have to go into debt to pay for it.
It is a wonderful feeling to have financial freedom. The stress level goes down when you don’t have as much to worry about on the money front. The less money you have to spend on debt, the more you have to spend on you; to retire earlier, to have a more enjoyable retirement, to move to a dream location, to quit your job and do something you love or are good at that might not pay as much, travel…
Too often we want the immediate satisfaction that comes with buying something today, or getting that bigger house or better car, but the love affair dies quickly and the shiny BMW doesn’t mean as much and the new home isn’t as nice as you thought and you start eyeing something bigger. Trust me you’ll get the same high when you’re debt-free that you do when you spend money. It is a great feeling to have freedom.