There are two ways of dealing with your debt situation.
Method A: sort it out yourself, using the system I will outline in a moment.
Method B: throw your hands in the air, admit that you’re totally out of your depth and get professional help.
If you know exactly what your debts are, what the rates of interest are (or you can find this information easily enough), and are already making some progress towards paying them off, Method A might be right for you.
If you are unsure about exactly how much you owe or at what rate, and you are too afraid to open those angry, registered mail envelopes that regularly appear, or to answer those persistent phone calls, you might want to skip straight over to Method B.
If in doubt, go to Method B.
Okay, with that said, let’s get cracking.
1. Make a list of all your debts, in order from the one with the highest interest rate to the one with the lowest interest rate. For example, your list might look like this:
|Debt .||Current Amount .||Interest Rate .|
|Loan from Dad||$3,000||2%|
|Loan from Gavin||$500||0%|
Pause here if you need a stiff drink.
2. Write down a similar list of all the money you have in the world. It might look something like this:
|Scase Bank savings account .||$244 .|
|Under the mattress||$60|
Subtract the total debt from the total wealth, like this:
$316 – $23,364 = -$23,048
That number is your net worth. It’s how much money you have. For some of you it will be a negative. We’ll come back to this.
3. You need to continue making the minimum payments on all these loans. However, to get rid of them one by one like zapping aliens in Space Invaders, you’ll need to aggressively make extra payments in order to more quickly get each debt down to $0.
Which one should you start with?
Pay off each debt starting from the top of this list. Focus all your efforts on this one debt. Put every spare cent into it. If you like, skip ahead to Step 5 in order to get ideas on increasing your income to turbocharge the process.
Remember, debts are negative wealth and cost you more money the longer they last. If it helps, imagine your debts as giant mosquitos sucking away your hard-earned dollars. Paying off more than the minimum is like spraying them with DDT. It might feel like paying back all this money is costing you, but in fact every dollar you repay is a step forward.
Go back to Number 2 and look at your total wealth. You’ll see that the more debt you pay off, the higher your total wealth will grow – even if it is just growing to a less alarming negative number. Refer back to that amount and recalculate from time to time in order to restore your motivation and assure yourself that you are making progress. Pretty soon this process will lead to a positive number. Imagine that. You’ll get there.
Once the first debt is paid off, congratulate yourself fulsomely! Get yourself an ice cream or something to celebrate. This is proof that the problem is not insurmountable. In fact, now that you’ve exterminated the financial drag of the debt with the highest interest rate, getting through the others will be that much easier. Momentum will build.
Now focus on the next debt down the list, the one that had the second-highest interest rate. Pay it off. Celebrate. Cross it off that dreadful list with relish. Then move to the next debt on the list. And the next one, and so on. As we have seen, those interest rates are like banknotes sprouting wings and flying out of your wallet. The higher the interest rate, the larger the wings and the faster your money flies away.
4. There might be good reasons for modifying the order of payments. For example, if Gavin is a good mate and you know he really needs the money back for his beloved dog’s operation, consider bumping him up the list. If he’s a bastard who once stole your girlfriend, leave him down the bottom where he belongs. By the same token, your dad might be willing to wait a while if you explain your overall plan. If you owe any debts to a large, rough looking chap called ‘Tony the Bulgarian’ who drives this year’s BMW despite being officially unemployed, put him right at the top of your list. You already did? Good.
5. Use this online calculator to see how long it will take you to pay off your debts:
For example, I entered the student loan of $11,240 listed above and found that if you paid in monthly $400 installments, you’d take a bit more than two years to pay it off completely.
At this point you may get a fright. What should you do if it would take an absurdly long time to pay off the debts? Say, longer than a normal human lifespan? Now that you’ve written everything down and done the math, your debts may seem more daunting than ever. Don’t panic! There are still some steps you can take.
6. If the situation appears hopeless, consider contacting your creditors and explain your situation. If this is a friend or relative you can do it yourself, but if it’s a company then you’ll probably need a debt counsellor to help you – go to Method B after reading the following. Don’t try renegotiation with Tony the Bulgarian.
Tell your creditor why you’re having trouble paying off the debt, make it clear that you’re trying your best, and ask if there’s any possibility of renegotiating the terms. Be very polite. Don’t lie – if your story keeps changing they obviously won’t trust you. If they do give you a concession, make sure you get this in writing. Such an agreement is called a ‘debt settlement’.
Lenders are sometimes willing to extend the repayment period or lower the interest rate if you’re frank and open with them because they’d rather get something back than nothing. Also, it costs them money to sell the debt to collectors (because those guys often buy debts for less than half the amount owed), and sending someone over to your house to repossess your reptile collection costs money, too. They’d often prefer to cut a deal.
A debt settlement will have a significantly adverse impact on your credit score so don’t pursue this course of action lightly. It is a last resort. A debt settlement is about the same as a delinquent payment, i.e. when you didn’t pay someone back the stipulated amount on time. This will make it harder for you to borrow in the future, and anyone who does loan to you will demand a higher interest rate.
7. Be wary of those debt consolidation businesses that kindly offer to roll all your debts into one. This sometimes leaves you with more to pay in the long run. Also, be cautious about more complex strategies such as refinancing or filing for bankruptcy. These moves are suitable for some people but you definitely need professional advice before going down any of these paths because of the risks and consequences. If you’re at that point then go straight to Method B.
8. Keep the lines of communication open between yourself and your creditors. If you disappear from the radar they will be more inclined to sell your debt to someone more persistent or to try to repossess your stuff. Respond to letters, emails and phone calls in good faith. Keep or record all communication (you can ask their permission to record phone calls).
The coming chapter on increasing your income will give you additional tools to step up your rate of payment. Once your debts are paid off, you’ll have a firm foundation for building future wealth and achieving a higher level of financial freedom.
Method B If you know you’ve gotten yourself into a pickle and doubt your ability to ever get out of it by yourself, approach [exclusive book content . . .]
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