The power of having a philosophy is that it can be applied everywhere and, if it is based on correct principles, it will yield extraordinary results. This is true with the Life By Design principles applied to finance.
Money and wealth are terms that are often frowned upon by most of society; terms like 'filthy rich come to mind'. This statement most obviously comes from the untrue idea that people with money had to harm someone in order to earn it.
For Life By Design money means potential. It means more opportunity for you and your family, it means more family time, another holiday, a secure education for your children, it means producing more for the people you love.
Welcome our expert - Garrett Gunderson.
One of the most debilitating areas of money is debt. It can prevent you from living an enjoyable life, but it can derail you from building the type of business that you want as well. Of course, it also impacts your ability to produce value as it can feel heavy and consume so much of your thinking and diminish positivity.
Let’s start by navigating a sustainable strategy that will not only create hope, but will insure a clear path that leads to more prosperity in the future with increased peace of mind today.
When it comes to addressing and overcoming the diminishing mindset that can come along with debt, check out the Curriculum for Wealth series to take a deeper dive. For now, it is time to get into one of the major strategies to overcome debt.
Hint: It’s not about your loan interest rates, nor is it just about socking away more money by cutting back or even just about saving money on interest. You want to get out of debt so you can reduce your risk, increase your cash flow, and have greater peace of mind, right?
Unfortunately, in a zealous effort to get out of debt, too many people make critical mistakes that increase their risk and make the process much slower than it has to be. It’s not just a matter of prioritizing which loans should be paid off first. It’s also a matter of minimizing your risk throughout the process.
Here’s the fastest, safest, and most sustainable way to do it:
1. Build Savings First
It doesn’t make any sense to start paying extra on loans until you have at least three months of income, and ideally six months, in a liquid savings account.
If you have no cash reserves, what happens when you pay down your loans but then experience an unexpected cash flow crunch? You simply increase your loan balances again or even worse, miss payments and hurt your credit score, therefore getting charged more for future loans and you can miss opportunities to lower your interest rates.
So before you even get started with paying down debt, build your cash reserves first. This puts you in a much safer and more sustainable situation. Don’t worry if you are wondering where that money might come from, details to follow, read on.
2. Raise Your Insurance Deductibles
Once you have cash reserves you can raise your insurance deductibles and extend elimination periods, which decreases your premiums, an extra benefit of having money in savings. This increased cash flow can then be used to strategically pay down debt.
I recommend using your home, auto, and liability insurance to primarily cover catastrophic losses. With higher deductibles (again, assuming you have cash reserves to cover small losses) you’re less likely to make claims, which prevents increased premiums.
The larger principle here is that when you approach debt elimination the right way it affects almost every other aspect of your finances. This is a more comprehensive approach that takes every factor into consideration, rather than looking at your debt in a vacuum.
3. Restructure Your Non-Deductible Debt by Rolling Short-Term, High-Interest Loans into Long-Term Tax Deductible, Low-Interest Loans
Again, the goal is to minimize your interest payments and maximize your cash flow. Then you can attack your remaining debt strategically, using your increased cash flow to eliminate one loan at a time.
Another benefit of this strategy is that it improves your debt-to-income ratio, which then improves your credit score, which can then be used to negotiate lower interest rates and will result in increased cash flow.
Having a better credit score also gives you more negotiating leverage. You can look into a streamline refinance on your existing mortgage. You can call your credit card companies, for example, and tell them you’re considering canceling and switching. They may be inclined to make their interest and terms more favorable for you, especially if you have a higher credit score.
Assuming you have enough home equity and after improving your credit, refinance your mortgage and roll as much of your non-deductible loans (credit cards, auto loans, etc.) into it as possible. The tax deduction will also increase your cash flow.
CAUTION: Do NOT do any of this if you’re undisciplined and your spending is out of control. If you’re just going to charge your credit cards back up again, you’ll just sink deeper into debt.
4. The Secret Sauce: Cash Flow Index
Here’s where the rubber hits the road. After minimizing your payments and maximizing your cash flow, you’re now prepared to focus on one loan at a time, thus creating the “snowball effect” until you’re completely debt-free.
Most financial advisors and pundits will tell you to pay off your loans with the highest interest rates first. My advice is to ignore the interest rate and use my proprietary Cash Flow Index to determine which debt to pay off first.
To determine your Cash Flow Index, take all your various loan balances and divide each of them by their respective payments. Whichever one has the lowest number is the one you should pay off first.
In Part 2 we will give specific examples, address the risk factor, get more into the roots and mindset behind debt and why it exists, plus tips to avoid finding yourself in debt ever again.