This “checklist” series of articles looks at common areas of spending to identify a list of opportunities to reduce costs. Not every tradeoff opportunity will make sense for you, but we hope you find this a helpful compilation.
The average American household has over $15,000 in consumer debt (i.e. credit card debt). If you find yourself to be “average” 1 “cause that’s what I love about you Harry, your a regular guy” in this area, we have good news. You have an amazing opportunity to save!
With average interest rates at 18%, there are few areas in our personal finances with a greater impact than removing consumer debt. Attacking and eliminating consumer debt from your life (and budget) can dramatically improve your finances and create margin to achieve your future goals.
Opportunities to Reduce Debt
Pay down using the “Debt Snowball”
Popularized by Dave Ramsey, the debt snowball channels all available resources to paying off loans from smallest to greatest. Its primary advantage is that it has the greatest positive motivational impact by quickly reducing the number of loans (and creditors).
Pay down using the “Debt Avalanche”
The debt avalanche seeks to extinguish high interest loans first, by channeling all surplus resources to getting rid of high interest loans as quickly as possible. Its primary advantage is that is removes the most financially damaging loans first. Mathematically, the so named “avalanche” does the job faster, but which you choose depends on your assessment of whether “motivation” or “financial relief” is most crucial to your personality.
Debt consolidation
Debt consolidation allows the lender to combined multiple higher interest loans into a single lower interest loan. This is risky, however, for two reasons. If the reason for consumer debt is embedded habits of poor money management, the borrower will invariably take on new debt after refinancing eases the short-term financial pressure and end up worse than before Consolidating with a mortgage (housing) puts the family’s primary shelter at greater risk. Notwithstanding the above, there are special circumstances when debt consolidation is prudent (i.e., such as when borrower discipline is not the root problem creating the debt), the details of the deal reduce interest paid, the loan is not extended, and there is strict accountability.
Debt negotiation
Creditors are often amenable to negotiating forgiveness for part of the debt when they perceive risk of non-recovery on the loan or loss of profitable business to a competing creditor (i.e. roll over on a credit card balance when the debtor has a history of on-time payments). The terms offered by the creditor should be received in writing and in advance of payment.
When it comes to trade-offs, consumer debt is something that rarely pays to have. We’ll talk elsewhere about the power of compound interest and just how much your money can multiply when invested. This is that in reverse…instead of multiplying your savings, it is draining your free cash and preventing you from getting where you want to go. There are rare exceptions where consumer debt is absolutely necessary, but this is a rare case where I strongly recommend that you avoid this at almost any cost! If you find yourself stuck in this trap, the good news is that you’ll be amazed at how money extra money you have available once you break free using any of the methods above.