Here in Australia, the major banks have increased their mortgage rates, and the “average” borrower (whoever that is) will be paying another $50 a month. I think that most people will actually be paying more. And when you add that to increasing credit card debt, it’s time to think seriously about debt reduction.
Vision, Mission, Virtues
I’m fairly sure that no one imagines a future with so much debt you can barely make the interest payments let alone reduce debt.
Freedom from debt is probably assumed not articulated, but if you’re in trouble, you might simply see
A debt free future.
In the shorter term, regular payments to reduce debt incrementally.
It’s going to be difficult, so let’s say Focus, Grit, and Discipline.
Debt reduction definitely needs a SMART goal.
Basic Spending Plan
We’ll use the same basic proportional plan with the after-tax monthly income of $3,435.
Unlike other goals, debt reduction starts with how much you can spare rather than what you want to achieve. Here’s how to work it out.
Write it Down
Rather than saving towards something, you’ll be paying back, so there’s nothing tangible to keep you motivated.
To deal with this, I recommend you write down how miserable you feel about the debt that you have. Be very explicit – this is the stick that opposes the carrot of your vision. What’s happening in your guts and to your shoulders. How do you feel when you see your credit card statement in your mailbox.
Get Rid of the Cards
I advise getting rid of the cards so you won’t be tempted to use them. Except one for emergencies, maybe two if you and your partner have different careers and needs. And I mean proper emergencies – not sales.
Calculate How Much You Owe
List all your debts – amount, monthly payment, interest rate, type of rate (daily, average, etc). We’re talking about credit cards, but add any family, loans or taxes that need to be paid too. Your payments may not be enough to cover the interest and fees, so add another $10 to each monthly payment so you’ll be making progress.
Now add up all the repayments so you know what the minimum amount to service your debt is.
Work Out How Much You Can Pay
Take a look at your expenses, and weigh them up against your Vision, virtues and goals. Are you spending money in pursuit of them, or against them? Where can you cut costs to allow extra for debt reduction?
- Food: Assuming that you’ve been eating out, let’s say you can cut your costs by $200/month.
- Housing: Unless you’re prepared to relocate somewhere cheaper, there’ll be no change here.
- Clothing: If you’re like most people, you have a wardrobe stuffed with clothes you never wear. For some reason, it feels harder to cut clothing than food, so let’s say $100/month.
- Operations: You may be able to cut costs by changing your phone plan, as well as simple household fixes like turning off lights and reducing/increasing your winter/summer climate control temperature by a degree or two. Let’s try for another $100, and keep looking for additional easy ways to cut costs.
- Happy Life: This is just the money left over when your other commitments are taken care of. It’s what pays for your goals, whether that’s education, vacations or gym membership. It’s important to continue to allow yourself treats to offset some of the pain of reducing spending. But if you’re serious, you’ll need to reduce their cost and frequency in favour of your larger vision. Let’s take $500.
Which gives us $900 a month to put towards the debt.
Pay the Debts Off
While you’re going to make minimum payments on all your debts, there are several strategies for paying down the balances:
- Highest to lowest interest rate.
- Lowest to highest balance.
- Debts that average interest (because they cost more).
- Highest penalties first.
I think it’s worth using a combined approach:
- If there are small debts you can get rid of in the first month or two, pay them off first.
- Then focus on the highest interest rate until you reach another debt you can pay off that month (then pay it).
- Switch between highest rate and lowest balance until they are done.
Don’t forget to:
- Close the accounts once they are paid off so you don’t accrue any more fees.
- Do a little victory dance.
Taking that all into account, our SMART goal becomes:
- Specific: $900 per month.
- Measurable: combined highest rate and lowest balance strategy reducing debts one by one.
- Achievable: you can do it, just have to really want to.
- Realistic: as long as you don’t overdo it, and allow yourself spending money, it’s possible.
- Timely: a hard deadline for completion, for example, close pay off and close five credit cards by 31 December.
Debt Reduction Holistic Spending Plan
There’s quite a significant change in expenditure which is bound to be quite shocking initially.
In exactly the same way that savings interest compounds, debt interest compounds too. When I was reducing my tragically high credit card debts in my twenties, I reduced my compound by putting my salary into the card I was paying off. I used it for all my expenditure until it was paid off. And then I did the same for the next. And the next. If you’re disciplined, it’s an additional tactic that might work for you.
Reducing debt is one of the hardest things you may ever have to do, but having done it once, you don’t really want to do it again. It’s a powerful lesson.
I put this Spending Plan together using the techniques I discuss in Holistic Personal Finance. If it’s not quite what you are looking for, check out these plans. or challenge me to develop something else in the comments below.