Key 2 – Pay Yourself, and Your Debts Correctly
This second week of our financial freedom quest we explore key 2. We’ll take a look at that cash flow that comes in and goes out every month because this is an immediate action you can put in place. It’s also easy to master. This is where the rubber meets the road. This week, we explore how to correctly pay debts and get started paying yourself first!
Many people out there make a classic mistake: paying their debts wrong. What I mean is that they are “hamster wheeling” – paying about the same amount every month and never making any real progress in debt reduction. Usually, people do this by slightly topping up what is paid on every debt. For example, they will round up all their minimum payments a few extra dollars or just to make the payment even across all of their accounts (i.e., $43 becomes $45, or they pay $100 on a $90 payment). This is a waste of time and money. You have two choices that will yield much better results: snowball or avalanche.
If time is most important to you, i.e., how soon you can pay off a debt, use the snowball method. This is where you pay off the smallest balances owed first. Thereby knocking out low-balance accounts over shorter time frames and you get a sense of progress.
If money is more important to you, use the avalanche payment method for debts. Mathematically, the avalanche method saves you the most cash over time. Using avalanche, you pay the debt with the highest interest rate first. So, if the amount of money saved and the amount of money you actually pay back over time is most important, use the avalanche method.
For either method, stop topping up all of your minimum payments. Take the total amount of additional money over and above your minimums that you have been paying on each account and add it to either the smallest balance account (snowball), or to the highest interest rate account (avalanche), in addition to that account’s minimum payment. Be sure that you do not miss paying the minimum due on each account you have. When one account is paid off, take that account’s minimum payment, the total amount of additional money from all the top up payments, and add it to the next target debt.
I use my planning software to model this out and make it visual for clients who are working on debt. I can show you how to structure your debts to save the most time or the most money depending on which is most important to you.
You need to take to heart that YOU are your most important creditor. Always pay yourself first! This can be challenging in the beginning, but you have to learn to do this and actually do it. If you are really tight on money, start with a small amount. Even if that amount is $5 per week. The key here is that you pay yourself first and that it becomes a habit. As your debt picture improves you will naturally increase what you pay yourself. The point is that you do it, do it regularly, and make it the first thing you do when you earn or receive any money. Pay yourself first! Always!
Not sure how to start or what to do first. Call me. As an independent Certified Financial Planner™, I can help you with a savings goal, debt reduction, setting a timeline and evaluating resources. #talktometuesday #education #Hireaplanner #savings #savemore #payyourselffirst #FiveKeysToFinancialFreedom #FinancialIndependence #CFPPro #goals