Reduce Debts

It can sometimes seem that debt is controlling your life but there is a way of taking back control and start to reduce debts.

Why reduce debts

Consumer debt is a massive drain on your finances and it leaves you vulnerable to the economy and other outside forces. Debt takes away your options and choices. It keeps you in a kind of slavery; you are in effect working for the Creditor (banks, credit card companies and retailers etc). Like Lewis Carroll’s Red Queen running faster and faster and not getting anywhere – truly this is a Rat Race.

But there is a way out of this slavery and below is a step by step process.

First List All Your Debts

It’s time to drag out all of your debts and show them the light of day. See my post on establishing what state your finances are in now, but briefly, make a list of your debts now:

Store cards
Credit cards
Bank overdrafts
Bank Loans
Car repayments
Even 0% finance
Mortgages

You are now going to allocate 10% of your net income to paying down this debt. This will be in addition to the minimum payments on each debt and also in addition to the 10% for Savings (Pay Yourself First). By now if you have followed through on paying yourself first, you will believe me when I say that you won’t miss this money. Well this is the same; so every payday you will allocate 10% to pay yourself first then another 10% to your Debt reduction fund.

Which debt should you pay off first

Which debt should you pay off first, should you pay a bit off each or one at a time? It can be confusing. There is a method of prioritising which debt to pay off and that’s based on the Relative Repayment Amount; Here’s how to do it:

Work out total balance remaining on each debt – Lets call this A. With your list of debts, dig out the statements or ring up the Creditor to find out exactly how much you owe.

Next find out what the monthly repayments are for each debt – B. Again you can get this from your statement or from the Creditor. List what the exact minimum payment is per month.

To work out the Relative Repayment Amount – C, take the total balance remaining A and divide it by the monthly payment – A/B = C

Rank the debts in order of Relative Repayment Amount C, with lowest number being the first. (The lower the number the bigger the drain).

Pay the minimum on EACH debt each month without fail. Vow never to miss a payment.

Use your 10% Debt Reduction Fund amount to pay extra on the debt with the lowest Relative Repayment Amount – C.

Once this is paid off use the 10% Debt Reduction Fund amount plus the first debt’s minimum payment amount to pay off the second lowest debt.

When the second debt is paid off use the 10% Debt Reduction Fund amount plus the first two debts’ minimum payment amounts to pay off the third lowest debt.

Repeat until all debts are paid off.

Now you are controlling and reducing debt, its time to think about what to do with your growing Capital. This will be the subject of a later post.