Most people don’t realize how easy it is to become debt free. Instead they envision a horrible drop in lifestyle and great sacrifices that include turning back the clock to medical school days where they were living on peanut butter and Top Raman. When in fact, no sacrifice is required to become debt free. All it takes is to decide that becoming debt free is what you want and then stop borrowing money.
If you think about it, the payments you are already making are designed to eventually pay off your debt. So if you simply stop borrowing money, and kept paying the regular payments, you would eventually become debt free. Most of us envision that day being 30 years in the future, which is when the home mortgage will be paid off. That seems like a long ways off. But in reality, following the no more borrowing rule will get you debt free a lot faster than you think, 70% faster in fact. Especially if you have many debts.
I remember having a conversation with a family about their debt, which exceeded $1,250,000. They wondered if it was even possible to dig out of the huge hole they created. Their debts included student loans, credit cards, business loans, car loans and both a first and second mortgage on their house. They were juggling 19 different loans. Keeping track of so many debts and making 19 monthly payments, totaling $12,000, was really dragging them down.
So I decided to put their numbers in my snowball spreadsheet and show them what really was possible. For those of you who are not familiar with the snowball technique, I will briefly describe it. You order the debts from smallest to largest without regard to interest rate. When the smallest debt gets paid off, add the monthly payment you were making on that small loan to the next loan on the list. As each loan is paid off, the amount of extra money being added to the loan continually grows. It’s the same effect as starting a snowball rolling down a hill and watching it get larger as it picks up more snow with each revolution. Eventually, the snowball payments come to an end and you are debt free. All the snowball money you were paying on your debts is now available for you to spend on your lifestyle, or better yet, to increase your savings.
Typically you would give the snowball a little push by adding some money to the first debt so it will get paid off quicker. But you do not need to add anything for it to work. The key is to stop borrowing money completely. Then once the first debt has been eliminated, it starts the snowball to pay off the rest of your debts more rapidly.
I put the above family’s debts into my custom snowball calculator, which I use for my one-on-one financial makeover clients. With no additional money added to the payments, if they were to let the snowball do its magic, they would be debt free in just 11.5 years. That is way faster than the 30 years they were expecting. Once you stop adding to your debt, debt freedom is guaranteed.
Since they are currently able to make all 19 monthly debt payments, they just need to continue making the same total monthly payments to become debt free in 11.5 years. That’s what will happen if they don’t change their current lifestyle. But what happens if they make some changes?
You can imagine, that if they can afford to make the payments on $1,250,000 of debt, they have a pretty high income. With a high income, they have the ability, if they desire, to make big spending cuts. If they were to spend $800 less every month and add it to their snowball, they would cut a full year off the time required to become debt free. In last week’s article, Success is not Measured by Income, Family B could come up with $800 a month just by reducing their monthly wine expenditure. There is usually room to make some cuts in every budget.
Following shows the amount of money that can be added to the $1,250,000 snowball each month to decrease their debt freedom date by one year:
$0 = 11.5 years to debt free
$800 = 10.5 years to debt free
$1,800 = 9.5 years to debt free
$3,000 = 8.5 years to debt free
$4,700 = 7.5 years to debt free
The biggest effect is not the amount of money they add to the snowball, it’s the decision to start the snowball in the first place that matters most. Without that decision, they will likely never get out of debt. Without making the conscious decision to become debt free, most people will continue borrowing money for things the rest of their lives. Every few years most people find a reason to refinance their house extending the loan another 30 years.
The simple decision, to stop borrowing money and let the debt pay itself off, changed this families prognosis from never becoming debt free, to becoming debt free in 11.5 years.
Since I know this family, I know they could afford to add $4,700 a month to the snowball with minimal effect on their lifestyle.
Their initial worry was that they would never be able to pay off all their debt. The reality is a lot better than they thought. Their debt can be gone in 11.5 years, without a single cut in their current spending.
That’s the way it is most of the time in life. What we imagine is usually worse than reality. This is a great example of the statement “Starting is half done.” The biggest factor in becoming debt free is not living an ultra-frugal lifestyle, the key is making the decision to become debt free.
The key to successfully conquering your debt is to decide to stop “managing” your debts and start “eliminating” them.
If you are ready to stop managing your debt and start on a new path to debt freedom, pick up a copy of my book The Doctors Guide to Eliminating Debt and begin your journey today. If you would like some individual help, contact me and we can explore the possibility of working one-on-one with me. It’s your future we are talking about.
Just a side note, when the family we discussed in this article finishes paying off their debts, they will have $12,000 a month in their spending plan to redirect, the amount they are paying each month in debt payments. Twelve thousand dollars would be quite a raise. What would you do with a $12,000 a month net income raise? I can think of a lot of fun ideas, as well as some practical ideas to make a better life in the future. In addition to having an extra $12,000 a month to spend, a great stressor is removed from their lives. What a great win-win deal.
Debt-free…mortgage free is the best way to live.
I paid off my mortgage a year ago. I fretted I was “losing money” by not being in the market.
Guess what? The bear didn’t hurt the value of the money I used to pay it down….
I highly recommend it.
Planedoc, great job. No one ever regrets paying off their house.
I agree. It is all about making the decision.
When people complain to me about their debt they are looking for some sympathy. Instead, I tell them to “pay it off” and then you won’t have to complain about it.
At first, they think I’m being dismissive. Then they realized I’m serious. If they ask me how I’m glad to tell them.
I’m amazed at how many students, nurses, x-ray techs, residents, and junior partners I have influenced to get out of debt. They all have thanked me. NOT ONE said getting out of debt was a mistake.
The earlier you make the decision the better. You won’t grow into your income and get used to spending it all. Pay cuts can be painful when you spend it all. Beware of lifestyle inflation and conquer the debt dragon early. I can be painless with a plan and determination.
The monthly debt payment is quite staggering at 12k a month but of course is because of the large initial debt.
I am curious. Did you calculate what potential time savings they would achieve if they did not use the snowball method of debt repayment but instead use the one I employed which some have termed the avalanche method.
Basically I did take into account interest rates and funneled money into the one with the highest rate first and then used that money to attack the next one down the list.
I know psychologically the snowball method gives a boost getting to see an actual loan being paid off but mathematically I just couldn’t bring myself to do it as it made more sense to get high interest stuff off the books first.
Another thing I was surprised was that adding $4700/mo extra only decreased the payment time by 4 yrs. I just guestimated a quicker pay down for that large a monthly extra contribution. Don’t get me wrong 4 yrs is a nice acceleration. I just assumed it would be even greater.
Thanks for your comments Xrayvsn. It doesn’t matter what method, avalanche or snowball you use, both will get you out of debt rapidly and at almost the same time. There is little difference between the two methods once you speed up the process and remove the time value of money. The longer you have a loan, the more the interest rate matters. Pay it off quickly and the interest rate become almost insignificant. As you saw, there is only a slight change with bigger influxes of money, (diminishing returns) that the big factor in rapidly getting out of debt is to decide to do it and follow through. I always begin with the snowball method and only move a loan’s position on the list if there is some compelling reason to take one of the loans out of order. Sometimes people have an emotional reason to pay off one loan sooner. Playing with the two methods, I like the snowball the best. In this particular case, the loan that made the most sense to pay off first was a 0% loan. It was a small loan with a large payment, meaning it would quickly put a lot more money into the snowball effect. It gives the fastest positive results. I remember the feeling I had when I paid off the first loan early, and I really got charged up to get out of debt. Since debt is usually a habit problem, breaking the habit is the most important factor. We must stop borrowing money if we want to get out of debt.