The 3 Ms to Paying Down Debt
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You’ve resolved, yet again, to pay down some debt this year. Want to increase your odds of success? Then make sure your plan includes all three of these key ingredients: motivation, money and method.
Here are the Cliff notes.
Motivation
Losing weight, losing debt, spending more time with your family: If you want to change your life, you’ll have to change your habits. And changing habits is no picnic; it requires strong motivation.
So, find something compelling to motivate you. I’ve lived debt-free for many years now, and here’s what motivates me: the realization that for every hour of my life that I swap for money (i.e., working) I’ve forever lost an hour of my life. Time is our only nonrenewable asset, so my goal is to spend as much of it as possible doing what I want to do and as little as possible doing what I have to do.
What does that have to do with debt? Everything. Because paying interest is a double-edged sword; it not only wastes money, it carries a high opportunity cost. Opportunity cost is accounting jargon for what money you spend today costs you in terms of the opportunity to have more money tomorrow. Let’s bring the point home with a simple example.
Say you borrow $100,000 with a 9.4%, 30-year loan and make minimum payments. You’ll make 360 payments of $833, for a total of about $300,000: $100,000 in principal and $200,000 in interest. If you earn $30 an hour, that means the interest bill alone totals about 6,700 hours of work: more than three year’s worth.
The real killer is opportunity cost. If you saved $833 a month for 30 years instead of spending it, and earned 9.4% instead of paying it, you’d have ended up with about $1,600,000. Translated into work hours, at $30 an hour, that’s 53,000 hours or about 26 years.
Of course, we can’t know the true opportunity cost in our example until we know what you did with the $100,000 you borrowed. Maybe you invested it into a business that’s going to be worth billions. However, one thing’s for sure, debt incurred to pay for things that go down in value (such as virtually anything that you can buy with a credit card) means huge opportunity cost, which in turn steals from you the most valuable thing you have: your life.
This is my motivator: what keeps me out of debt. However, if that’s not motivation enough for you, find something that is because without strong motivation you’re probably doomed to failure. Of course, motivation alone won’t do the job. You’re also going to need…
Money
The more extra money you can find in your budget, the faster you can be debt-free. Step one in finding it is to use a spending plan (i.e., budget) to track where your money is going now. Then, see where you can save. When you do, don’t launch into a “dollar diet” and deprive yourself of the things you love. Deprivation doesn’t work. Instead, decide what really makes you happy, then try to spend less doing those things. Impossible? Not at all. Eating an appetizer at home, then splitting an entree at the restaurant is still eating out. The books at the library are no different than the books at Barnes & Noble. I drive an $85,000 Mercedes, but I bought it “pre-owned” for $20,000.
I could go on. Suffice it to say, no matter where your money’s going now, there are ways you can save without sacrificing quality of life. I know because I don’t just write about this stuff, I live it. With the exception of a small mortgage, I’ve been debt-free for nearly 20 years and have accumulated more than a million dollars in savings as a result. And nearly all of it has come from saving small amounts where I can and investing those savings sensibly.
So, if you’re looking for savings, here are the ABCs: A) Ignore what society and commercials are telling you. Make a list of what you really want or need; B) Stop spending on things that aren’t on it; C) Explore ways to save on things that are.
And once you’ve found some extra cash, all you need is…
Method
Pick a system for destroying your debt and stick with it. When it comes to ranking debts for pay off, the method I advocate is called snowballing.
Snowballing means ranking your debts for payoff, then focusing every spare dollar on the first debt on your list till it’s dust. Then, using that old debt payment to help pay off the next debt on the list — and both those old payments to pay off the third debt on the list, and so on. You continue snowballing old payments until you’re debt-free. Then you invest the total of all your old debt payments every month and watch your wealth snowball as compound interest starts working for you rather than against you.
The bottom line? Destroying your debts is doable and it will absolutely change your life. Work it and it will work for you.
The 3 Ms To Paying Down Debt Provided by AskMen.
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10 Comments so far
leave a commentAbout 15 years ago I was laid off and could not afford to make the payments of my debt (over $40K in unsecured debt) despite having UI benefits. I borrowed enough money from my family to tide me over until I got another job, but at that point I vowed to not let it happen again.
That was my motivation – the freedom from debt is also the freedom from worry about job security. To be truthful, I still worry, but just much less, especially now that I have two years of living expenses readily available (not including retirement funds). I am also motivated by the ability to take risks with my career by taking positions I am more happy with, even if the organization is not stable.
Moreover, as you mentioned, costs of goods is much less when you do not have to pay interest on the item because you borrowed money to purchase it. This allows you to have a higher standard of living – but requires some patience and sometimes a bit of sacrifice; I drove around a beater Toyota for 4 years until I could pay cash for my Bimmer.
congrats! you give me hope
cc debt = 46K+ in june 2008, currently 32K. on track to be out of debt in 3 years. I lost my job this year too, found another one. still driving my 10 year old civic.
Your description of opportunity cost is incorrect. You’re in the ballpark, but not quite there. 1st- its not an accounting concept…its from economics. 2nd- A better description is that because money is a fixed resource (ie- you can’t print your own) whatever you do with any given dollar requires you to not be free to spend that same dollar on something else. Time definitely has an opportunity cost as well. Otherwise, this is a great article.
The flip side of the pay-it-off-early coin is, again, opportunity cost. (Incidentally, your use of the term seems the reverse of its normal uses; I’ve usually seen it used when considering a “normal” course of action versus a special opportunity.) If you have high-value opportunities only available now that require that extra money, the cost of missing such opportunities may outweigh the cost of extra interest payments. For example, I delayed entering the workforce for five months after graduating from college to thru-hike the Appalachian Trail. I’ll pay extra interest on student loans for that choice, and more notably I’ll miss half a year of extra compounding of retirement savings and other accounts where I might have invested that money, but the opportunity cost of starting work (and loan repayment) immediately was too great to do it, no matter how much — on paper — it may have made sense.
Of course, once that opportunity finished, I immediately began work and loan repayment at a rate much faster than that dictated by minimum payments (perhaps too fast, actually, given the loan’s interest rate and my other goals). I’m not saying what you suggest is *always* wrong — just that it’s quite possibly wrong for *short* periods of time, or even perhaps long ones if your opportunities now and well into the future are sufficiently compelling.
Good article but i think you lost steam on the third M, the METHOD. Its equally as important. if you dont have a good method, you may never escape your debt. You could have told readers there are two main methods for paying off debt. The first is officially called the snowball method http://en.wikipedia.org/wiki/Debt-snowball_method where the card with the smallest balance is payed off first. The only point in doing this is to keep the motivation climbing when it is the lowest at the beginning. The second method is actually cheaper and faster but provides no emotional satisfaction. I dont know if it has an official name, but it involves paying off the highest interest rate card first. You can use a calculator such as this http://cgi.money.cnn.com/tools/debtplanner/debtplanner.jsp
Dear Stacy,
You rock! Thanks for sharing your knowledge and your life experience.
You have helped me to continue on my path to financial freedom.
These two other comments from Bryan and Jeff…well let’s ignore them they are super full of themselves….but Mr Heretic is also a great motivator. Thanks so much for sharing.
I’m curious why you think I’m “full of [myself]“. I merely suggested that paying it all off immediately sometimes may not be the right strategy if your immediate opportunities are good enough — but it’s a personal question to which different people will have different answers. If I were full of myself, wouldn’t I have said everyone should do exactly as I did?
Or was that in response to the economics terminology quibble? If so, I confess that I have a bit of the economics wonk in me, and I like to see terms used in precise accordance with their generally-understood meaning.
Imprecision just muddies the waters for people familiar with the terms. I’d rather see a clear, longhand description that doesn’t use a term, if the alternative is a shorthand that slightly misuses a term.
I am fortunate to only have my house and four years left on a car as my major debt. Thankfully I have a wife who shares the same views I do on money and that is to invest first, save second, spend third.
What really turned me around was figuring out exactly what was coming and going each month and then making decisions to make sure I spend less than I earn.
I love the three tips here as well. You need motivation, money, and a method. My motivation is I want to retire and live. My money is what I invest each month. My method is spend less than I earn, and invest what’s left.
These are some really big points. When it coms to motivation, if you don’t want to do it and don’tcommt yourself to it you wil never pay off your debt. The snowball cocept really works well too. It can be tempting to pay off higher interest debt first but stay comitted to the snowball concept and it wll pay off in the long run.
I have personally tried both methods, paying off smaller debts for motivation and paying off higher interest first. In my opinion, I prefer paying off smaller debts first because getting that feeling of putting a credit card debt to 0 is satisfying. It also gives you the feeling that you can do it again for the next debt and you’ll gain momentum in saving/budgeting correctly.
There’s different ways to motivate people so find out which works best for you.