~By David Wright
Last night I was chatting with one of my clients who had previously purchased an investment property off the plan and when it was completed he found it was a lemon! The rent was not going even close to covering the repayments and it was sucking them dry each week.
That is not an uncommon scenario, and whether it is a house, a car, a swimming pool, a boat or some other thing or things that caused the problem, it’s easy to find yourself with debt that you regretted taking on. So today I thought I should talk about getting out of debt.
I don’t think it matters who you are or how much you earn, most people have debt and many people have more debt than they are comfortable with.
I think it would be fair to say that for most people if they found themselves to be totally out of debt it would not surprise me if they decided to go into debt so they could acquire something they otherwise could not have without waiting for it.
I.e. Most people don’t mind making loan payments if those payments are easily affordable and the loan was for something useful.
Debt problems begin when your payments gobble up so much of your income each week that you find it difficult or even impossible to cover your essential weekly expenses.
If you are smart you will take on debt for things that go up in value or generate more income than they cost. If you are foolish you will take on debt for things that go down in value and generate little or no income.
I remember years ago buying an expensive car and later regretting it. When I began to look at my options I found that selling the car was not going to allow me to pay out the debt. It seemed we were stuck between a rock and a hard place.
Years later I’m able to look at that situation and see it in a different light.
Let’s look at an example:-
You purchase a car for $25,000 and borrow the lot.
Interest rate 12%
Monthly repayments $550
You find you can only sell the car for $20,000 so you feel trapped. If you sell, you lose $5,000 and would be making loan payments on a car that you didn’t even own for some time to come!
So you keep the car and keep struggling to make the repayments.
But if you did sell that car for $20,000 and were able to purchase a $5,000 car instead and you kept making the $550 monthly payments on the remaining debt you would save $7,411.90 in interest, so after allowing for the $5,000 loss you would actually end up $2,411.90 in front!
If you reduced your payments to $220 a month you would pay $5,102 less interest so after allowing for the $5,000 loss you would end up $102 better off!
Taking one step backward would actually allow you to take two steps forward!
If you have multiple debts you should consider snowballing the repayments as individual debts are paid off and contrary to popular opinion you would be crazy to put any surplus payments towards paying off your smallest debt rather than your highest interest rate debt.
Your smallest debt is just about always going to be paid off first anyway so there is no real psychological advantage in focusing on that one when you could be saving a lot more interest by attacking the debt with the highest interest rate.
~ David Wright, Co Founder of the Spending Planners Institute
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