Debt has to be the single biggest factor holding people back from achieving their financial dreams. It was a never-ending cycle of debt that forced me to question what was going on, I had my financial freedom realisations. I needed a debt management plan for eliminating debt and becoming debt free. If not, I was going to retire with debt. This was despite earning more over the years.
In debt for Life
The debt that I had was home loans and car loans as well as a seesaw debt cycle with credit cards. Luckily I did not have the worst kind of debt which is consumer debt and short term loans. I had always known what debt was costing me.
From the first house that I bought I had done calculations and realised how much money I was paying in interest over a 20 year period. So I always tried to pay in extra amounts into my bond to reduce this interest and the total period. The problem was that I kept on upgrading houses and taking out new home loans or just extending my bond.
So after owning homes for 20 years, I ended up at the age of 45 owning a house and a rental property with a total loan amount of R2.9M. The car loans amounted to R200K, so in total my debt was R3.1M.
At the end of 2019 I was successful in eliminating debt and becoming debt free. I achieved a significant goal in my journey to financial freedom. I achieved this by being completely focused on paying off my debt and put all my effort and energy into it. My target was to have it paid off by 2022, but I beat that target by 2 years.
Why is debt so bad?
There are many fancy terms for debt like, dues, arrears, financial obligation and outstanding account. Don’t be fooled the bottom line is that you owe somebody else something, money. You effectively give away your freedom when you go into debt. Besides the money that you take, you have signed a contract with the other party to say that they have some control over you.
It is even worse than that. Once you have several debts then even people who you don’t owe have power over you. When you need to borrow more money or apply for something they look at your credit score or your income vs expences and if you owe too much you can’t do what you want to.
Financially debt is bad because it is expensive, it is a critical part of financial literacy that needs to be understood. It costs you more. Once you have paid off the item you will have paid significantly more for it.
Eliminating debt can save money
Lets just take a car for example, if you buy a car for R100 000 and you take out a loan at 10% for 5 years to pay for the car, the total cost will be R127 482. That is an extra R27 482, 28% more. If the salesman told you, buy this now for R100 000 or pay me later and get it for R128 000 would you take that deal?
Lets look at a house for R 1 000 000, the loan you get is normally for 20 years, lets use 10% interest rate again. The total cost of the house once you have paid it off will be R 2 316 051. You will have paid an extra R 1 316 051, that’s more than the cost of the house! If you have a choice to pay off the loan sooner say 10 years then the total cost will be R1 585 808, that’s R 585 808 more or 59%.
Don’t think that it is any different on smaller items like consumer cards and credit cards. The effects are far worse there because the interest rates charged can be double or tripple that you would pay on a car or a home loan.
Over time the amount of money you are throwing away in interest payments will make you cry and make you poor. On top of all of this you have to deal with worry, anxiety, credit scores and potential relationship issues caused by debt pressures.
What is the main cause of debt?
The main cause of debt is overspending. You are spending money that you do not have. You will still have to earn this money in future. So you are deciding to spend it now even though you have not earned it yet.
What will you do in future when you have to spend what you have just earned to pay for what have already used in the past? How are you going to pay for what you need to at that point?
You are gambling on the idea that you can spend the money now and then earn it in the future. What happens if you don’t get increases, what happens if there is an emergency, what happens if you lose your job, what happens if a pandemic comes and you can’t work for 3 months?
What are the warning signs of a debt problem?
When you are paying a significant portion of your income to debt +20%(excluding rent and mortgage) and do not have any money to save, you have a problem. Taking cash out of your credit card to pay other accounts or pay expences, you have a problem. Using your savings to pay for daily expences, you have a problem.
How much debt is normal?
The fact that we even ask this question tells you how acceptable and normal debt is today. People also refer to acceptable debt or good debt. This would be debt on assets that can generate value, like a property or a business. All other debt is said to be bad because the items bought lose their value over time, like cars, clothes and furniture. My view is that all debt is bad because it costs you significantly more money. It adds risk to your finances and it takes away your flexibility and ultimately your freedom.
How to avoid debt?
If you followed the principle that you only buy what you can afford and save up for everything then you can avoid debt. If you can pay something off over 6 months, 1 year or 5 years, then why not save up for 6 months, 1 year or 5 years?
The only item where I would concede is a house, but then I would save up as much as possible to make a big deposit and spend as little as possible. This way you can keep your loan as small as possible. Allowing you to make additional payments and have the best chance to pay it off in a quarter or half of the required term.
How to reduce debt?
You need a plan for eliminating debt and becoming debt free. The first step to reducing debt is to stop accumulating more debt. The second step is to find some extra money to pay off the debt faster. Very few people get out of debt by paying the bare minimum, this takes too long and you will lose motivation. So you have to find extra savings on your expences or earn more money.
You will need a plan of action and some targets to help you focus. Two approaches to consider, start with the smallest debt first. Or start with the debt with the highest interest rate, often these are the same. I recommend the smallest first as you can have some quick success, build momentum and feel you are achieving your goal.
Paying off debt requires consistency and discipline. These are the same qualities that successful investors have. So already you are developing good habits.
My plan for eliminating debt and becoming debt free
When I started we had credit card debt, car loans and two home loans. I also had some money invested in stocks that I had held for quite sometime and had been building up. This was not part of any real strategy and some of the stocks were performing and others weren’t.
As part of my new plan I would be eliminating debt and becoming debt free first and then focus on building investments. This was an important decision because it brought focus and allowed many things to happen and made subsequent decisions easier.
How I refocused and paid off 50% debt in one year.
The most expensive debt and the smallest was the credit card, then came the car loans and the home loans. The first target was the credit card debt. My access bond had some extra money in it so I used this money to pay off the credit card debt as the interest rate was lower and I could eliminate one debt all together.
The next step was to sell the stocks that I had. They had grown nicely since the 2009 financial crisis so I was happy to bank the profits. This money I used to settle a large part of the car loan that I had. The rest of the car loan I increased the monthly payments by the maximum that I could afford at the time.
As part of the first steps to financial freedom we relooked our expences and found ways to make additional savings. Most importantly these additional savings helped us avoid further debt or to slip back into debt once the credit cards were settled. The additional savings also freed up cash and this was all put into the home loans.
One of the home loans was for a property investment that I had. This was supposed to be part of my long term investment strategy but it was not working out. It was not properly thought out and was not delivering acceptable returns, see my property investment experience here. The best option was to sell the property. That eliminated another loan and I used the profit to decrease my home loan.
The hard slog to kill the homeloan
Within the space of one year I managed to halve the R3M debt and simplify my life by eliminating 3 out of 4 major loans. This just left me with a single home loan. This progress and success gave me the motivation to carry on and complete the hardest part which was killing the home loan.
This last stage was the hardest part but also the part that I am most proud of as it required the biggest amount of discipline. After all these savings as well settling the other debts my cash flow had increased significantly. In addition I had a promotion so my salary had increased. In my old world this would have meant getting my dream car or doing those additions to the house or going on that overseas trip that we had dreamt of.
None of this happened thanks to my financial freedom realisations and my early retirement plan that I had crafted. Instead, I spent every cent and some extra to pay into my bond. I was able to pay double my current monthly bond payments. The most satisfying feeling was seeing that loan amount come down as I paid more of the principle amount and the interest portion decreased.
Finally becoming debt free
Five years after I started this process I became debt free. If I had not had this plan and focus I would still have been in debt. Once again at this point I could have opened the spending taps but I didn’t. After almost a year now I have kept that discipline and I have been putting every cent and some extra into my investment portfolio every month.
I do have one confession though. As a reward I agreed with the family that when we become debt free we will take that dream overseas trip. It was all planned for the end of this year but with COVID we may need to postpone.
How to pay off debt in six steps
- First stop creating more
- Find extra savings in expenses, Use extra savings to increase payments
- Target smallest debt first for early success then move to next
- Declutter sell items or assets not used anymore
- Consider other sources investments or savings to pay off big chunks to build momentum
- Maintain consistency & discipline repeat cycle from 1
You shouldn’t take any of this as advice, consult a professional financial advisor for that. This is merely what has worked for me and my experience.What are you doing about eliminating debt and becoming debt free? Share below in the comments.