Set A Goal And Create A Budget
One of the common things people do to get out of debt is set a goal and create a budget. In fact, that is exactly what I did when I decided I wanted to be debt free.
The reason creating a budget is one of the best ways to get out of debt is that you can see and dictate what money is spent where.
To help you get started, I will send you a FREE Budget template when you .
Tips For Adopting A Debt
- Create a budget. Its crucial to create a written plan to help you prioritize how you will use the money you earn, especially if youre on a debt-free journey. Your budget doesnt need to be complicated. You can use a simple sheet of paper, a detailed spreadsheet or even a budgeting app to get the job done.
- Achieve positive cash flow. There are two ways to accomplish this goal raise your income or reduce your expenses. Doing so gives you a better chance of earning more than you spend, which is positive cash flow. Achieving a surplus each month gives you more choices and money to work with as you cultivate a debt-free lifestyle.
- Pay attention to your credit. A good credit score can sometimes help you get out of debt faster. With excellent credit, you might qualify to consolidate your debt at a lower interest rate so that more of your payments go toward your principal balance and less goes toward interest.
- Make extra debt payments. Once you free up extra funds, either through spending cuts or additional income, Ashburn advises using the money wisely. One of the best places you can apply your extra dollars is toward debt.
- Create an emergency fund. It may seem counterproductive to save more money while youre trying to pay down debt. However, an emergency fund can help you avoid debt when unexpected expenses arise. Reaching your goal of zero debt isnt just about paying off your debt as fast as you can its about planning for the future, too.
Funding Your Retirement First
Unfortunately, while its better to pay a mortgage off, or down, earlier, its also better to start saving for retirement earlier. Thanks to the joys of compound interest, a dollar you invest today has more value than a dollar you invest five or 10 years from now. That’s because it will be earning interestand the interest will be earning interestfor a longer period of time. So each year you delay saving for retirement will hurt you a disproportionate amount.
For that reason, it generally makes more sense to save for retirement at a younger age than it does to pay down a mortgage sooner. You can estimate your retirement savings with the U.S. Social Security Administration’s calculator.
Of course, investments dont just rise they fall, too, and their performance can fluctuate wildly with the financial markets. The returns, alas, arent usually as fixed as mortgage payments are. But thats all the more reason to start investing sooner rather than later. Your portfolio has more time to recover from roller-coaster behavior by the market. And the stock market has historically risen over the long term.
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Things We Gave Up To Be Mortgage Free
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If you are new to this site, we became mortgage-free at the beginning of this year. More recently, we just became debt-free this past week!!! One of the questions I get a lot is, How did we do it. While I usually allude to having a big Why, it is more important than the How. However, I realize that the How is important too. I mean, what good are intentions if you dont have a way to act on them.
Becoming mortgage-free or living debt-free doesnt just happen. It requires work and sacrifice, just like anything else in life.
Think of it like this a bank will typically approve you for three times your salary pre-tax for a mortgage or give you up to a mortgage of 35% of your familys take-home income. If you are already paying 35% of your income to your mortgage, its going to make paying off your mortgage a challenging feat.
It can be done!
Here is a list of things we gave up to pay off our mortgage.
Paying Down Your Mortgage First
Let’s say youre finally in the home stretch with a mortgage you took out years ago. Its been a long haul, and youre tempted to pay it off in one final payment and finally be free and clearor, at least, accelerate your payments a little to be done sooner.
While it may seem tempting to pay down your mortgage near the end, its actually better to do so at the beginning. Although you make the same size payment each month , most of your money in those early years is going toward interest and doing little to reduce the loan’s principal.
So by making extra payments early onand reducing the principal on which you’re being charged interestyou could pay considerably less in interest over the life of the loan. The same principles of compound interest that apply to your investments also apply to your debts, so by paying down more of your principal early, the savings are compounded over time.
By contrast, in the later years, your payments are going more toward the loan principal. Paying more wont reduce your total interest burden as quickly itll just build your equity in the home faster . Not that theres anything wrong with that, but were looking for the best uses for your money.
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How You Handle Your Debt Can Be Decisive Too
Whatever cards or loans you already have, the manner in which you look after them is critical. Show youve a steady hand, repay on time and keep your spending under control, and itll go a long way towards proving youre a good bet.
Say you have a trio of credit cards for good reason one for cashback, another to rack up loyalty points and a third for overseas travel. Spend lightly on all three with regular repayments, and youll unlikely be marked down.
But itd be a different story if you had a trio of cards you used only for spending, with credit balances constantly close to or pushing at their limit. A lender may well think this habit points to future difficulties.
For a clue as to how a lender might consider you as a mortgage candidate, check to see how much credit youve been given access to and what you actually use. Compare the two as a percentage the lower the figure, the better. If your credit cards have a maximum spend of £5,000 and you currently owe £1,500, this puts you at 30%. As a guide, a borrower with a healthy would typically sport a figure of 25%, according to credit agency Experian.
What Does It Really Mean To Be Debt
Quick Answer
Being debt-free means you dont owe any outstanding debt. However, carrying no debt other than your mortgage payment or a credit card you pay in full each month could make sense.
In this article:
For most people, living debt-free is a meaningful goal that represents a level of financial freedom. Student loans, car loans and credit card debt can feel overwhelming, but eliminating debt can relieve the stress.
But what does it really mean to be debt-free? For some, being debt-free means living without any outstanding debts, while for others, it may mean living with only “good debt,” such as a low-interest home loan. Let’s examine the different definitions of being debt-free along with useful practices to achieve a debt-free life.
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Are There Disadvantages Of Being Debt Free
I am a big believer that there are pros and cons to everythingexcept when it comes to debt. In my opinion, there is no advantage to carrying debt.
There are some people that tout the disadvantages of being debt-free, but I think their arguments are weak. The benefits of debt free living clearly outweigh carrying debt.
Why Should I Prioritize Retirement Savings
Consider this when thinking about saving for retirement: thanks to the joys of compound interest, money you invest today will grow and grow and be worth more by the time you’re ready to enter the golden years. That’s because it will be earning interestand the interest will be earning interestfor a longer period of time. So each year you delay saving for retirement will hurt you a disproportionate amount.
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Next Focus On Debt Repayment
Its important to note that your individual debt repayment strategy will vary based on what type of debt you have. If you primarily have student loans, for example, you may be able to look into deferment, forbearance or loan forgiveness through your loan provider. If you are mostly dealing with credit card debt, these solutions will not be available.
Regardless of what kind of debt you owe, there are two common strategies for repayment: the snowball method and the avalanche method. Both will ultimately help you reach debt-free living but in slightly different ways.
The snowball method consists of listing your debts by total amount and paying off the smallest ones first, slowly working your way up to the most expensive. This strategy is more focused on the psychological benefits of paying off debt. Many people find that the satisfaction you feel when paying small amounts first is highly motivational and helps lessen the emotional burden of debt.
With the avalanche method, you rank your loans based on interest rates, rather than by the total dollar amount. Then you focus on paying off the balances with the highest interest rates first, while continuing to pay the minimum each month on all other loans. This can be particularly helpful if you have credit card debt in addition to student loans or other types of loans, as interest rates are typically higher on credit card accounts.
The Math Behind Paying Off Your Mortgage
For the most part, I ignored the math, although I knew in my head what the consequences of mortgage payoff would be.
At a 5% interest rate and a 40% marginal tax rate, I was effectively paying about 3% a year on the principal. This was true because I had itemized deductions.
If you take the standard deduction, which will be much more common with the increased standard deduction resulting from the Tax Cut and Jobs Act, you are paying the full mortgage interest rate, getting no deduction on the interest you pay.
If your itemized deductions barely surpass the standard deduction, youre essentially deducting very little of your mortgage interest. Its good to know where youre at with deductions.
Back to the math, where I had plenty of itemized deductions. Assuming the principal that I owe is working for me and invested in my portfolio, I would need at least 3% returns in a given year to break even on carrying the mortgage.
Perform better than that and carrying the mortgage wins. Underperform 3% returns and mortgage payoff wins.
The math is simple. With todays low interest rates, I would say carrying the mortgage wins more often than not from a probability standpoint. From a psychological standpoint, being debt-free is a state of being that has significant value thats much more difficult to quantify.
I chose the option to be debt-free and havent regretted it one bit.
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Money In And Money Out
To be successful at debt free living, you must know how much money is coming in and how much money is going out.
If not, you cant get control of your money situation.
Then, you cant learn how to get out of debt, youre not organized with your personal finances, and financial freedom or retiring early is out of the question.
The advantages of budgeting are real.
Do you want to control your money? Or have money control you?
Stick around at Money Bliss. We have plenty of resources to help you learn to manage your finances your way. Plus enjoy life with money!
Money In / Money Out Task: Figure out where your money is going. That is essential to help you move forward. Here is my favorite budgeting app / software.
Add Up What You Owe To Avoid Surprises
Perhaps you use a couple of credit cards for all your online shopping, and dip into your overdraft once a month? Or maybe you pay for a car loan monthly, and keep store cards for special offers.
Whatever your choice of credit, its part and parcel of being able to look after your personal finances and any lender you approach for a mortgage will assume you have these kinds of debt already.
But while you wouldnt be expected to have a perfect or be completely debt-free, lenders will want to know how much you owe overall. Why? To be confident you can take on a mortgage on top of your existing debt without getting into difficulty.
To help it check if youll be fine, a lender will work out how much of your monthly pay goes on repaying debt and decide if its too much or not.
For example, imagine your monthly income before tax is £3,000. You pay £200 towards a car loan and £100 on your credit card. With hopes for £700-a-month mortgage, this would take your monthly debt to £1,000.
Your lender then divides the two for a figure £1,000 debt against £3,000 income would give 33%.
Although its a general calculation, you might hear it called a debt-to-income ratio .
As a rule of thumb, the lower your figure the better and 33% would be a strong score. It suggests your personal finances are in decent shape to take on a mortgage, and youll likely get a competitive interest rate.
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Does Debt Free Mean No Mortgage
Oh, this one is a hot debate!
Everyone has an opinion on this subject Are you debt free if you have a mortgage? Does a mortgage hold you back from being debt free?
So, lets look at both sides of the coin.
Debt is debt. You are borrowing money and repaying the principal back plus interest. You arent able to make much progress financially because debt will slow you down. The debt payments eat away at any possible savings and attempt to reach financial independence.
Many people saying you are debt free when you are free of consumer debt specifically credit card debt, car loans, student loan debt, medical debt, or personal loans. That is when people say, I am debt free except the mortgage.
Other people say you are debt free when you are free from ALL of your debt obligations including your mortgage.
Here is the caveat to that debt free / mortgage debate and I will use myself as the example:
We could sell our house today and claim to be debt free including our mortgage. However, we wouldnt have a roof over our heads and would have to find somewhere to rent. The cost of rent to stay in our area would be 2-3x our current mortgage.
So, that wouldnt make a lot of financial sense just so we could say we are truly debt free .
Now, the next debate would move to a lower cost of living area to keep the rent the same as our current mortgage. A few problems with that: we wouldnt be building equity in our house as an asset and we would have to take a pay cut because of jobs.
You Might Want To Pay Off Your Mortgage Early If
- You’re trying to reduce your baseline expenses: If your monthly mortgage payment represents a substantial chunk of your expenses, you’ll be able to live on a lot less once the payment goes away. This can be particularly helpful if you have a limited income.
- You want to save on interest payments: Depending on a home loan’s size and term, the interest can cost tens of thousands of dollars over the long haul. Paying off your mortgage early frees up that future money for other uses. While it’s true you may lose the tax deduction on mortgage interest, you’ll have to reckon with a decreasing deduction anyway as more of each monthly payment applies to the principal, should you decide to keep your mortgage.
- Your mortgage rate is higher than the rate of risk-free returns: Paying off a debt that charges interest can be like earning a risk-free return equivalent to that interest rate. Compare your mortgage rate to the after-tax rate of return on a low-risk investment with a similar termsuch as a high-quality, tax-free municipal bond issued by your home state. If your mortgage rate is higher than the interest rate on an investment asset, you’d be better off paying down the mortgage.
- You prioritize peace of mind: Paying off a mortgage can create one less worry and increase flexibility in retirement.
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Use Savings To Pay Down Larger Debts
Don’t be afraid to use a portion of your savings to pay down high-interest rate debts. Using cash reserves for debt repayment is a smart decision because you will stop accruing interest on those large balances. Although it may feel comforting to have some extra cash sitting in your bank account, the truth is that those funds aren’t really working for you not with today’s record low interest rates. Don’t deplete your savings entirely. If you’re sitting on a pile of cash, do use some of those funds to eliminate your bills.
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