Debt Elimination

What is Debt Elimination?

To be clear I am talking about debt elimination, not to be confused with debt consolidation. They are two different processes with different aims and outcomes. Whilst debt elimination may embrace some debt consolidation, if it makes financial sense, but it’s key objective is to help you become debt free, not simply combine a number of smaller debts into one larger one. This often simply hides the debts and does little to help you get rid of them.

Debt elimination requires a different mindset to debt consolidation.

Our mindset must be clearly focused on applying a structured method and discipline to follow the process. If not, the results will be diluted and it is easy to become disillusioned and give up.

Why do it?

The reasons can include

• Your debt level is getting a little out of control and you need to take action
• You have surplus income and want to use it to best effect rather than spending on unnecessary doodads
• You are starting to approach retirement age and want to retire without any debts
• Too much of your income is getting tied up in servicing loans and debts and you want to free up cashflow in the medium term
• It’s simply time to take action

How to eliminate your debts

Here are some basic steps that you need to take to be successful at becoming debt free, or at least getting them down to a comfortably manageable level.

1. Know your starting point

Determine your current financial position. This includes both your assets and liabilities ie what you own and what you owe and your income and expenses. Key numbers to find are

• The current value of your principal assets ie house, investment property, car,etc
• Current home, car, personal loans and credit card limits and balances.
• Current repayments and interest rates on each of the above
• Your current net after tax income for all income sources. These will primarily be your net salary or income from your business.

2. Do a Budget

The fundamentals of debt elimination are to focus your cashflow in the best way possible to target and progressively eliminate your debts. The starting point is to determine your cashflow. This means doing a budget. If you already have one, great, if not this is the first thing to do.

It’s a bit like being a detective with your own finances. You want to know how much surplus cash you have available after your expenses. Sounds like an easy exercise, but it will challenge you more than you think.

Firstly determine your net income after tax. Then go through your expenses and deduct the total of your expenses from your net income.  This is your surplus.

Determining your major fixed expenses such as loan repayments, rates, insurances, utilities, food etc is relatively easy. It’s the black hole that we call discretionary expenses which will be the hardest to quantify.  But, this is where your hidden money hides. This includes your entertainment, pocket money, eating out, coffee on the run etc, all of those types of expenses.

3. Extra Cash - the more the better

Debt elimination by default means that you are accelerating the repayments of your debts. If you are not able to release/find surplus income from your current spending, you will find it very difficult to increase the rate at which you repay your debts.

The Process

Once you have determined all your current debts the current repayments and interest rates on each and your surplus cash, you’re ready to start.

We are going to approach debt elimination with a laser focus, taking on one debt at a time. There are many opinions on which debt to start with. You could choose the one with the highest interest rate, you could choose the smallest debt. What I suggest is you simply divide the debt by the monthly repayment. This will give you “factor”. Do this for each debt and then rank them from the highest “factor” to the lowest.

You will focus your additional repayments into the debt with the highest factor in addition to the regular payment you make to that debt. Keep making the minimum repayments on each of your other debts.

When the debt with the highest “factor” is paid off, then take the repayments you were making on the first debt(including the surplus) and pay into the second highest ranked debt until this is paid off.

Keep repeating this process until all debts are paid off.

Your home loan will be the debt with the lowest “factor”. By the time you have paid off the smaller consumer debts, you will be in a position to rapidly accelerate the repayment of your home loan.

TIP: It is critical during this process that you refrain from taking on more debt or keep using that credit card that you are trying to pay off. If you do, it will not work and you will lose motivation and give up. The chance to be debt free will slip away.