One of the main plagues of unwise financial habits is the accumulation of bad debt, which in turn, makes it really difficult for many people to live a debt free life.
Unfortunately, when it comes to household debt, i. e. debt held by household occupants for things such as mortgage, car loans, education loans, and credit card loans, statistics show the US is one of the most indebted countries in the world.
Due to the sheer size of its Gross Domestic Product or GDP, United States doesn’t quite take the podium and is beaten by Sweden, Australia, and other countries, figuring only 13th in the World (as of April 2020). But its shocking, average household credit card debt per person of around 9000$ a year reveals a more sinister story.
Many families, in fact, live above and beyond their means, surviving paycheck to paycheck, bleeding money into credit institutions to pay for a lifestyle that is barely sustainable.
Do you see yourself in this description? If that’s the case you need to take action now.
In this article, we are going to look at the difference between bad and good debt and then look in-depth into a single strategy to eliminate bad debt quickly and decisively. Finally, we look at ideas to keep bad debt away for good.
Why is it so difficult to get rid of bad debt?
There’s no need to be ashamed of admitting it. We’ve all fallen prey to credit institutions with offers so enticing it’s almost impossible to say no. Then, when you are wrapped in debt and costly repayments and with minimal available cash flow, it may feel very difficult to regain control of the situation as you are bleeding money from multiple wounds.
Bad debt Vs Good Debt
To top it off, its often hard to distinguish between good and bad ways of using the credit card. The great potential of having a line of credit is often squandered in dubious impulse purchase.
Not all debt is bad, in fact, some form of debt is excellent.
Simply put, good debt allows you to purchase cash flow while bad debt acquires liabilities. In other words, good debt creates positive cash flow during its lifecycle while bad debt creates negative cash flow and ultimately a net loss.
A car loan buys you a transportation vehicle, for sure, but it also burdens you with a highly depreciating asset that is costly to maintain and operate.
A mortgage on an investment property allows you, instead, to purchase an appreciating asset that can be paid off with someones else’s money (the tenant) and sees you wealthier when the debt is paid off.
Obviously, you want to stay away from bad debt and instead use good debt to your financial advantage.
Now let’s see how you can take the bad debt out of your life once and for all and live debt free.
To top it off, its often hard to distinguish between good and bad ways of using the credit card. The great potential of having a line of credit is often squandered in dubious impulse purchases.
I won’t lie, this is going to require some sacrifice but is going to be worth it in the end. In fact, the money you free from the vicious cycle of debt can be used to improve your financial situation or to provide a safety cushion to an economic downturn, giving you peace of mind.
The idea is simple in principle. You save as much money as you can and start repaying your debts focussing on the higher interest one. Then you focus on the next one down the list. When that’s extinguished you move further down until you are free.
I’ll provide further guidance now on how to actually do it, however:
Before you do anything, please, stop using your credit cards. The last thing you want is to keep creating wounds while mending the ones you already have. Take’em out of your wallet and instead just use cash. It’s inconvenient as hell but, bleeding money is way more inconvenient. Force yourself to pay cash only until all your debt is settled.
Let’s look at an hypothetical but common scenario
Let’s look at an example. Let’s say you have the following lines of debt:
- Debt n1 – Entertainment system
original cost 2500$
80$/month repayments
interest rate: 22.5%
time to repay 48 months
total interest paid 1297$
Final cost 3797$ - Debt n2 – House renovation work
original cost 6000$
200$/month repayments
interest rate 18%
time to repay 39 months
Total interest paid 1790$
Final cost 7790$ - Debt n3 – new-car loan
original cost 36000$
518$/month repayments
interest rate: 4.9%
time to repay 72 months
total interest paid 5832$ - Final cost 41832$
This adds up to 798$ a month or 9576$ a year in debt. You can realistically eliminate it in half the time or better and saving yourself a huge amount of money in the process.
Where to get the extra cash to repay debt faster
Your finances are already stretched thin, you are paying already 798$ a month, where do you get the extra money to repay it faster? You have more options than you think, in fact, you can and you must:
- Start saving like there is no tomorrow – Look for expenses you can safely cut. Can you save on petrol by cycling to work? Can you cut Netflix and cable tv for a while? Can you make coffee at home instead of buying an expensive latte every day? There are so many ways you can save money it’s almost ridiculous. We have a money-saving guide for a recession and we listed many ways to save on food and entertainment on the site. The amount you can easily rack up monthly by combining all these ideas easily goes into the hundreds for many people.
- Get a side hustle and make lump-sum repayment – if you can get hold of extra money, a side job, selling things on eBay, or any other activity, use these to make voluntary payments into your credit card to reduce the amount owed.
- Debt swap – this is an advanced technique and we’ll talk about it later but basically consists of repaying high-interest debt with another 0% interest or low-interest line of credit.
- Sell the things you purchase on debt and repay the debt (if the option is available to you) – Let’s be honest, this is extreme, but if your financials are stretched thin and you are desperate this is a perfectly legitimate option.
Extinguish your debt step by step
Step 1 – Let’s say you are saving 120$ p/month with the help of our strategies and frugal living, now you pour this extra cash into debt n.1. This brings total monthly repayment to 200$. Now you extinguish it in half the time (around 27 months) and pay only 370$ interest instead of 1297$.
Step 2 – By the time you end up extinguishing debt n1, only about 24 months are left for debt n.2. Now that you have freed 200$ per month, you keep doing the frugal living and pour these 200$ into it. Again, you are going to take half the time to repay it completely (around 11 months) and save more than 1200$ in interest.
Now, I bet you see where we are going with this.
Step 3 – Finally, you take what you have freed, again 200$ + 200$ and pour it in your car loan. Now you are contributing 518$ + 400$ to its repayment every month and you are going to finish it off much, much quicker!
This is it! It’s a simple strategy that is proven to work.
A deeper look at debt swapping
I mentioned before about debt swapping, let’s talk for a second about it.
If you do not have the capacity to save extra money every month or find yourself overwhelmed, you could sign up for another line of credit with a different financial institution offering more favorable repayment options than the ones you are on at the moment. If you are smart about it you could improve your financial situation considerably.
For example, the U.S. Bank offers a very attractive offer on its Visa Platinum card, with no annual fees and 18 months of interest-free on balance transfers and purchases. You see how you could use something like this to transfer your debt to this card and repay it without interest within the interest-free period. It’s a perfectly viable solution if you really are in dire streets even though I am not a fan of it.
The reason is that it requires discipline with the new card. You need to track your balance transfer and the interest free-period carefully, plus you still need to stop using your other credit cards and reduce your expenses in general. I believe learning to live more frugally is a very useful exercise in financial self-discipline. However, as I said, if you do need it, the option is there for you.
Stop creating bad debt and start living debt free
Now to round this article off a few final suggestions to keep bad debt away for good. Getting rid of it is not going to be easy so you want to work on your ‘retention’ for sure.
A few simple ideas to further speed up repaying bad debt, improve your household cash flow and stop creating bad debt:
- Pay cash. It is well established we don’t feel the sting of partying with our money when using a card. Use cash instead, to limit your spending.
- Use a debit card instead of a credit card. It pulls from one of your accounts and won’t allow payment if you do not have sufficient funds. It increases complexity and requires planning, therefore, helping to control your spending while offering most of the conveniences of a credit card.
- Keep only one credit card handy and repay charges monthly. It’s easy to set up automatic repayment through your bank, set it and forget it and don’t incur fees and repayment interest anymore.
- Implement our advice for frugal living