05: How we get in & out of debt

Let’s talk debt.

Today I will discuss how we get into debt and how to get out of debt.

What is debt? Debt is the price we pay to buy money. What? I’m guessing you probably haven’t thought of it that way before. Am I right? When we purchase something in advance on our credit card or by taking out a loan. What we are doing is buying money. Let me explain. We borrow the money to pay for the item such as a new pair of jean, a large bill such as our car rego -that by the way we have to pay for every year yet somehow seem to forget that and have to come up with the money from somewhere each year. We pay for that item with the money we borrow. We now own that item but then we still have to pay for the money we borrowed and the money we borrowed will always cost more than what the actual item cost. Are you still following me?

I will give you an example: A common debt people have is a car loan. Let’s say you take out a loan for $29000 for a new car and you pay that off over 7 years. I just quickly punched in the numbers on a big 4 bank website and it came back with the result, using the current variable interest rates I would end up paying a minimum of $42000 or up to $47000 for the life of the loan for a $29000 car that is going to depreciate in value instantly the minute you buy it.

Now I don’t know about you but paying an extra $13000 for the price of the borrowed money- some people call it interest seems crazy to me! And that’s the minimum interest. You may end up paying $18000 more. I mean seriously you could get a pretty nice second-hand car with $18000.

This is how borrowing money can really mess with your finances because the cost of that new shiny thing you so desperately want right now ends up costing you so so much more.

So how do you stay out of debt?

There are a few simple steps that I will out line now.

  1. Spend less than you earn
  2. Have a budget to know what your regular expenses are. It doesn’t have to be complicated
  3. Put aside the money for those regular expenses
  4. Spend consciously
  5. Save money for a buffer account
  6. Don’t have a credit card if you can’t control your spending
  7. And finally please don't compare yourself to the Joneses, who cares what they are doing or think.  Easier said then done!

First thing first

step 1 - Spend less than you earn. Duh! It’s that simple. In fact I could just end this article here but for some reason so many of us really struggle with this- why?

I think it is a result of a variety of reasons. Many of us spend unconsciously. We just put things on the card without thinking, like my coffee buying example I mentioned in Planning for your dreams. If you missed it I just told a story about when I calculated how much money I was spending on takeaway coffees each year it was way more than I imagined because I had never consciously thought about it before.

Step 2 Have a budget – this is a great way to spend less than you earn. When you write out all your expenses you quickly know if you are over spending and can see where to cut back. This goes hand in hand with

Step 3 Put money aside for your regular expenses - I cover budgets in How do you spend your money? and discuss ways to manage your accounts to budget for expenses in Allocate and automate. If you haven’t listened to them already I would recommend checking them out to help you with these steps.

Step 4 Spend consciously -We often get into debt simply by going unconscious and overspending. If you have more stuff than money you are over spending. This is a concept that might take a moment to sink in. Marie Kondo and Minimalism seem to be a big trend at the moment and I can understand why. Some of you might not like this or be ready to hear it but how much of your stuff do you actually use? How much of it do you love and have because it has a purpose or you just absolutely love it and want it in your life? I will tell you now that I am certainly improving in the area of not overspending but just like you I get it, you want something so bad. It’s new it’s shiny, it’s obviously going to make your life so much better, easier, happier but after the initial dopamine hit of obtaining that new shiny thing it becomes dull and old quicker than we care to admit and it is just another thing that we are still paying for that is cluttering up our lives.

I think I could do a whole episode on this but to summarise buying a lot of stuff you don’t need on credit is a tricky business that can quickly get you into debt for no good reason. I’m not suggesting you don’t spend any money or buy nice things just start be deliberate about how you spend your money. Know in advance what you want to buy. Save for it. Really question yourself about the purchase. When I’m wigging out on something I that has caught my eye and I’m umming and ahhing whether or not I should get it I sometimes ask myself in a month’s time or 6 months time will I still want this thing or will I want the money?

Step 5 Have a buffer account - I will cover this in more detail in another episode but I believe it is very important to have a 'buffer account', 'emergency fund', 'oh dear account' what ever you want to call it. Have a least 3 to 6 months expenses saved to cover any unexpected emergencies. This is such a stress relief account and will save you having to go into debt when an emergency comes up and they will come up on occasion.

Step 6 Don’t have a credit card if you can’t control your spending - Some big guns of the personal finance world say you shouldn’t have a credit card and I don’t disagree although full disclosure I do have a credit card. We are very disciplined with our credit card and pay it off every month but truth be told I’m not convinced I need it and am starting to question if we should just get rid of it altogether. My argument for a credit card is that if you are disciplined with paying it off on time, you have one with no or low fees that you can accumulate points with why not? I usually buy myself something with the points each year, which is a nice little treat. But on the other hand are points really that useful. Do you really use them and are they worth getting into debt over. I have recently experimented with putting most of our direct debits onto the credit card to earn more points as we have the money budgeted for and I just transfer it over but I am finding sometimes I lose track and recently had to pay interest because I wasn’t paying close enough attention. This was a simple and silly mistake that I wouldn’t even have to bother with if I simply didn’t have a credit card. I’m assuming if you are reading this you are a full grown adult who is perfectly capable of making decision for yourself so I will let you decide what is best for you. However, if you are like some people I know who just can’t help themselves. Do yourself a favour. Get rid of your card.

And finally

step 7 Don't compare yourself to the Joneses - Another reason we find ourselves in debt is that old cliché of keeping up with the Jones. Let me tell you that the Jones are up to their eyeballs in debt.

I feel pretty confident about this now. Let me explain. I use to think everyone around me must just earn a lot of money as they all seem to have such nice cars. But now that I am in a situation where my partner and I are both in professional jobs and earn decent money I realise many of those people with the nice cars got themselves into debt to have them. I think it is considered pretty normal to finance a car.

Let me tell a little story about this. Years ago I used to drive to work in a rattly old car and I car-pooled with a colleague who had a much newer, nicer and more comfortable car than me. Now at the time I could have financed a car but I was determined to save up for a house. For sure at the time I felt uncomfortable and a little embarrassed and as silly as it sounds to me now every time my colleague drove with me I thought about how I longed to get a new car but thank goodness I stuck to my guns and didn’t give in to that old cliché of the Jones as in a few short year I had the deposit for our first property and also enough to buy a new second hand car that we still drive today. And look my past self would have loved to have keep up with the Jones, by getting into debt for a new car but my present self is so grateful I didn’t get sucked into that because that one decision to keep saving laid the foundations for the investments we have today.

The crazy thing is nobody probably even paid any attention to the car I had. I’m sure it was all in my head, and if it wasn’t who cares. I would much rather have the investments I have now than a car debt on a car that would be getting old now anyway. The moral of the story is be ok with being you. Yes it’s great to have new things but think seriously: are you doing it unconsciously because that’s what people do or would you rather make deliberate decision about spending on what is really important to you.

I’m imagining after saying all that some of you might be thinking- That’s all really great to know but I wish you could have told me that before I got up to my eyeballs in debt. How do I get out of the debt I already have I hear you ask?

Step 1 Write down all your debt

Including the interest rate and the minimum monthly repayment.

Step 2 List your debts smallest to largest

Logically it makes sense to pay off your debt that has the highest interest first but psychologically for some people it is more effective to start seeing some wins early. If you can knock off some debts quickly it can motivate you to keep going with it.

Step 3 Snowball your debt repayments

Dave Ramsey an American personal finance coach outlines in his book The Total Money Make Over to do the following:

Pay the minimum off all your debts. Meanwhile pay extra on your smallest debt until it is paid off. Then the money you were paying towards the first debt now gets added to repaying the second debt and so on. Each time you pay off a debt more money is added to pay off the next debt hence the snowball effect.

If you want to learn more about this or find out about books about money check out my books page here.  I have listed all the books I have been reading and I write a little summary of what the book is about. This is a great resource for you to access if you want to learn more about managing your money but need some help with finding information. You can read about the books and see if they are suitable for you. I have read a large range of books by different author whose opinions and advice vary. Some I love and highly recommend others are not my style but may appeal to you.   I tend to focus on the information provided rather than the author’s style. For Example Dave Ramsey is an outspoken Christian man who has a very conservative voice which may not appeal to some but he has a lot of great information in his book so I don’t let that deter me but it might not be your cup of tea. On the other side of the spectrum is Melissa browne and her book Unf*ck your Finances.  Which may not appeal to others.  The point is check out the resource page as there is something for everyone.

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