Building Your Estate: 2 Essential Debt Reduction Concepts

November 7, 2010
300px Credit cards Building Your Estate: 2 Essential Debt Reduction Concepts

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First in an occasional series about foundational financial planning strategies.

I have been fortunate enough to receive some nice feedback on this post about ways to spend an extra $1,000.  In the following weeks, I will take an individual look at each of the 12 foundational strategies listed as ways of building your “estate” more quickly.

Paying Down Debt

There are two simple yet vital concepts you need to embrace to rid yourself of debt faster.

1.  Stop Spending More Than You Earn

I know, I know, this is obvious.  But remember, if you are currently outspending your earnings, your net worth is declining.  It doesn’t take a genius to figure out that the worst way of reducing debt is to keep increasing it.

If you are in this dilemma, go get your pay stubs, checkbook, and credit card statements.  Calculate your average monthly income and expenses.  Then, figure out how to increase the income and/or reduce the expenses.  1-2 hours.

I’m not a big proponent of detailed budgets, since life usually does not allow for such rigidity.  However, doing this exercise will boost morale, because making such changes is truly not as hard as you think.  Here’s an example.

Illustration:  $1,000 Per Month Deficit

A recent client and his wife were spending $1,000 more than they were earning every month.  He already works and commutes 60 hours a week, and his wife stays home to care for their two toddlers (and even watches two others for free 3-4 days a week).

Let’s presume here that the bank won’t help, their savings is gone, and there are no parental dollars to borrow.  In that case, their best bet is to adjust by doing a bunch of little things rather than one or two major changes:

  • Charge for “daycare”. Income: $400 per month (including licensing and insurance).
  • No Starbucks or McDonalds.  Bring coffee and lunch to work.  Savings:  $200 per month.
  • Cut coupons and switch to store brands.  Savings:  $150 per month.
  • Cancel movie channels and limit “Movie Nights”.  Savings:  $100 per month.
  • Library instead of bookstores.  Savings:  $50 per month.
  • Read the fantastic “The Simple Dollar” blog to find the final $100.

2.  Pay Off the Highest Interest Debt First

You’ve broken even.  Now, list all of your debts in order from the highest to lowest interest rate.  Then, pay as much as possible monthly to the top debt listed, and just the minimum to all the others.  If you can get your rates lowered or even transfer debt to tax-deductible sources, all the better.

Illustration:  Five Debts

Let’s say you have two credit cards, a school loan, a car loan and a mortgage.  List them in order of highest interest, like so:

Credit Card 119.9%$5,000$300$50
Credit Card 218.9%$7,500$350$60
Car Loan8.9%$4,500$350$350
School Loan6%$6,000$175$175

Doing a back-of-the-spreadsheet analysis, it would take 38 months to pay off the first four debts, and about 24 1/2 years to pay off the mortgage.

Instead, pay as much as you can Credit Card 1.  Here, paying $605 to Credit Card 1 and the minimums to the others each month, will pay off Credit Card 1 in nine months.  Then, add that amount each month to the next highest-interest debt, Credit Card 2.  Continue in this fashion until all your debt is paid off.

Assuming you pay the same $3,000 each month as if you had made no changes at all, using this strategy, you would instead pay off the first four debts in under two years and the mortgage in just over 12 years.  You would save over $100,000 of interest payments as well.

So there you have it.  Stop adding to your debt.  Pay the most expensive debt first.  Bask in your accomplishment.

 Building Your Estate: 2 Essential Debt Reduction Concepts
 Building Your Estate: 2 Essential Debt Reduction Concepts


Scott R. Zucker, Esq. is the owner of The Zucker Law Firm PLLC, located just outside the Capital Beltway in Annandale, within five miles of the City of Fairfax, the county seat of beautiful Fairfax County, Virginia. The firm focuses mainly on estate planning services for Virginia, Maryland and Pennsylvania clientele, and seeks to do so in an affordable and approachable way. People interested in learning more can contact Scott by phone or email.

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