Have you encountered the debt monster?
At first, he hardly bothers you. In fact, he even helps you out of a tight spot now and then.
But as time goes by, he grows. His teeth sharpen and claws become fearsome.
No longer just a mosquito-like annoyance. He begins to get in your way, obstructing you from your goals.
Then, before you know it, he’s huge. Impossible to ignore. And, quite frankly, dangerous. You find yourself in a state of constant worry that his appetite will become the end of you.
The problem with debt
If you’ve encountered a debt monster like this one, you’re not alone.
South Africans, on average, spend 75% of their disposable income on debt service. That’s monthly payments for home loans, car financing, credit cards, and bank overdrafts.
In Nigeria, credit cards charge interest rates of 2.5% — per month. In Kenya, many charge 3.5%.
And they come with a host of hefty fees on top of that. Annual fees equal to 2% of the total credit limit are common.
With terms like these, it’s no wonder that the debt monster takes a bigger bite out of your income with each passing month.
Debt reduction is sure-fire wealth creation
When it comes to finance, there are few guarantees.
Share prices rise and fall. Bonds can default. Even banks have been known to let their depositors in the lurch on occasion.
Paying down debt, however, always yields a positive return.
The more you reduce your obligation to creditors, the more cash you can keep in your pocket.
An unbeatable rate of return
And not only is the return on debt reduction guaranteed, it’s likely of a size to make the long-term performance of even the fastest-growing stock markets look puny.
Let’s imagine you have 100,000 shillings of debt on a credit card that charges an interest rate of 3.0% per month.
If you didn’t make any payments on the card for 12 months, how much would you owe at the end of the year?
Assuming, the credit card company didn’t charge any late fees and/or drag you into court, you would owe a total of Ksh142,576. And that doesn’t even consider the card’s annual management fee.
Therefore, each Ksh1.00 you pay toward your credit card debt results effectively results in a savings of 43 cents over the course of the year — a 43% annualized return.
At rates like that there’s nothing better to do with your excess cash than to pay down that debt as quickly as possible.
How to tame the monster
What’s the best way to tackle your debt?
- First, take your credit cards out of your wallet and hide them in a place where you won’t be tempted to use them to purchase inessential items. If you completed last week’s first step toward successful investing, this shouldn’t be too uncomfortable to do.
- Next, list all of your debts on a sheet of paper. Note each one’s outstanding balance and its annual interest rate. (Do you have credit card debt that’s stated in terms of a monthly interest rate? You can convert it to an annual rate here.)
- Now, start paying off the debt with the highest interest rate. Make sure you pay at least the minimum required on each one of your debts, but reserve the lion’s share of your disposable income to pay down the one with the highest interest rate. This will give you the best return and tame the monster most quickly.
- When that first debt is eliminated, move on to the debt with the next highest interest rate. Rinse and repeat until the only debt remaining is your home loan if you have one. Home loans generally carry relatively low interest rates, and, in many cases, a home increases in value over time – unlike a vehicle or piece of furniture. Thus, it probably doesn’t need to be a priority for you to pay off.
- Celebrate your success.
Have you tamed the debt monster?
Congratulations! You’re on your way to the next step toward successful investing.
It’s your turn
How did you tame your debt monster? Do you have any tips to share? Let’s hear them in the comments!