Welcome back!
Building Out is about helping people journey from employee to a place of time and financial freedom. On this journey, we often talk about the sexier world of investing, business and tax as a way to build passive income and the journey towards time and financial freedom.
But there is a 3rd key topic/skill you need to understand and master to be financially free. That is paying off your debt.
Personal debt can act oppositely to compounding returns and instead keep you poor by an ever-spiralling negative compounding that ultimately acts to hold you back.
It’s like building speed in a car but having the handbrake on simultaneously!
This blog article examines why debt is so common, the importance of paying it off, and two key approaches to starting this.
Why Is Personal Debt So Common?
The reality is that people take on debt for several reasons. This debt can often spiral if you need help keeping up with repayments.
Sometimes, debt can be related to life events such as job loss, paying care fees for elderly relatives, or a significant life event, which means quickly needing access to increased funds.
However, debt runs much deeper than that in our society, with many people often needing to understand the implications of debt for them. In the ever-expanding digital world of social media, we must avoid comparing ourselves with people we know.
Want a new car? Get it on credit.
Need the latest updated phone? Take out a contract agreement
Deserve that holiday as you’ve been working hard? Get it on the card.
These are all examples where credit and personal debt are often used to pay for things we need or deserve.
There is often a range of emotions associated with this, from being impulsive and feeling you need to have something to deserving something because you’ve worked hard in your job. Other emotions include feeling you must provide a certain level of material things to the people you love.
Our decisions on consumer debt are often fuelled by emotion, not logic.
In addition, the idea of debt is written into our money belief programs and those of people around us.
Regardless of the reason, emotion or personal script we have, the more of it we have, the more it is holding us back.
The Importance of Paying Off Debt in Building Wealth
How much are you paying each month in debt interest payments?
The average person has absolutely no idea.
But for every pound that goes towards paying off any form of debt, less is available to invest. This debt reduces your ability to build a life of time and financial freedom.
As of June 23, average household debt excluding mortgages in the UK was £34,597 for an individual and £65,529 for households.
Interest rates differ, but let’s take the figure of £34,597 and assume a 7% interest rate; this works out at about £200 per month to pay the interest on the debt per month.
If we were debt-free and took that £200 every month and invested it with a very conservative 7% return over 20 years, this would leave us with £104,000!
If your interest rates for borrowing are even higher than the figures, get even more eye-watering!
Avalanche vs. Snowball: The Debt Repayment Showdown
Regarding conquering debt, two popular strategies often come into play: the Avalanche and the Snowball Method. Both strategies have their merits, and understanding the difference is key to choosing the right one for your financial situation.
- The Avalanche Method focuses on paying off debts from the highest interest rate to the lowest. This method is mathematically efficient, saving you the most money in interest over time. It requires discipline and a long-term perspective, as it may take longer to repay your first debt fully.
- The Snowball Method, on the other hand, advocates for paying off debts from the smallest balance to the largest, regardless of interest rate. This method offers quick wins, providing psychological boosts by clearing individual debts faster. It’s particularly effective for those who need visible milestones to stay motivated.
Both strategies will be explored in further detail in future posts, but understanding their core principles is a crucial first step in tackling your debt.
So, where do I start?
A common mistake to make when that is rising and either debt payments are becoming an issue, or the level of that is becoming more manageable is to ignore it.
People often do this to assess it, which leads to negative emotions. It’s like finding out how much you weigh at the beginning of a diet! It may be unpleasant, but it is an essential first step.
The five pieces of information you need to start are the debt item, how much remains to pay off, what the interest rate is, how much each month you pay in loan repayment vs interest payments, and how many months to pay this off.
You can write the figures can be written down in a notebook, Excel spreadsheet, or a scrap of paper, but you must write them down.
For those using notion, I have a template for this below:
The next step is taking action once you write down and know where you are. My next two blogs will cover the avalanche and snowball methods.
If you want to make sure of receiving them, sign up to build out a blog here:
In addition, if you want more personal finance and business tips on your path to time and financial freedom, follow us on social media for regular updates.
Good luck on your journey!
Leave a Reply