More and more people are getting swallowed up by debt. Iâ€™m sure youâ€™ve read and heard many of the statistics and stories in the news.
One of the keys to financial independence is to get rid of your bad debt and acquire good debt. Bad debt is debt that makes you poor, such as credit card debt, car loans, school loans â€“ this is consumer debt. Good debt is debt you acquire that actually works for you. The best example of good debt is a mortgage loan on a rental property that throws off positive cash flow every month. Good debt is money that you borrow to purchase assets that puts money in your pocket.
In 1985, Robert and I had a good deal of bad debt. And even though we kept making payments every month, we never seemed to make a dent in the amount of debt we owed.
Each month we paid a little over the minimum on each one of our credit cards as well as on our car loan. Obviously, there had to be a better way to get ourselves out from under our creditors. And sure enough there was.
â€œStick with the Formulaâ€
This is the formula that Robert and I followed to pay off our debt. Youâ€™ll find that if you follow this formula you will be out of debt much quicker than you imagined. Most people find themselves â€œbadâ€ debt-free within 5 to 7 years. The key is to stick with the formula. You will not get ahead if you say, â€œIâ€™ll just skip this one month,â€ and then two, and then three. If you stick with the formula it then becomes a habit you follow for a lifetime.
Here is the formula we used:
Step 1 â€“ Stop accumulating bad debt. Whatever you purchase via credit cards must be paid off in full at the end of each month. No exceptions.
Step 2 â€“ Make a list of all your consumer (bad) debts. This includes each credit card, car loans, school loans, home improvement loans on your personal residence, and any other bad debts you have acquired. (One item on our list was an outstanding debt to a partner from one of Robertâ€™s past businesses.) You can even include your home mortgage in this list.
Step 3 â€“ Next to each items listed make 3 columns:
– Amount Owed
– Minimum Monthly Payment
– Number of Months
Enter the appropriate numbers into each column. To arrive at the number of months, simply divide the amount owed by the minimum payment.
Step 4 â€“ Based solely on the Number of Months begin ranking each debt. Put a â€œ1â€³ next to the lowest number of months, a â€œ2â€³ next to the 2nd lowest number and continue up to the highest number of months. This is the order that you will be paying off your various debts.
Get Your First Win!
The reason you will start with the debt with the lowest number of months is that you want to have your first â€œwinâ€ or success in this process as soon as possible. Once you get that first credit card (or debt) paid off, youâ€™ll begin to see the light at the end of the tunnel.
Step 5 â€“ Come up with an additional $150 to $200 per month. If you are serious about getting out of debt â€“ and, more importantly, becoming financially free â€“ then generating this extra money will not be difficult. To be candid, if you cannot generate an additional $150 per month then your chances of becoming financially independent are slim.
Step 6 â€“ Pay the minimum amount on every debt you have listed EXCEPT for the one youâ€™ve marked with a â€œ1.â€ On this first debt to be paid off, pay the minimum amount due plus the additional $150 to $200. Keep doing this each month until your first debt is paid off. Scratch that first debt off your list.
Step 7 â€“ Congratulate yourself!
Step 8 – Pay the minimum amount due on every debt you have EXCEPT for the one youâ€™ve marked with a â€œ2.â€ On this debt, pay the minimum amount due, PLUS the entire amount you had been paying on debt #1. For example if on debt #1 your minimum amount due was $40 and you added the additional $150 then you were paying a total of $190 each month. On debt #2, if the minimum amount due is $50, you will now pay $50 plus $190 or a total of $240 per month.
After a debt is paid off then take the total amount you were paying on that debt and add it to the minimum amount due on your next debt to get your new monthly payment. You will be amazed at how quickly this amount adds up and how quickly your credit cards, car loans, etc. are paid off.
Continue this process until all the bad debts on your list are paid off.
Step 9 â€“ By this time the monthly amount you are paying on your last debt is likely to be quite substantial. Keep paying that amount every month. Except now â€“ instead of paying it to creditors â€“ you pay it to yourself for only one type of purchase: assets that give you positive cash flow each month. You will be out of the Rat Race faster than you ever dreamed!