Debt Payoff Techniques
With the new year, many will set forth on making new financial goals for themselves while also revisiting goals from the previous year. This is a perfect time to reevaluate one’s financial plan, budget, and cash flows to ensure they are still on the correct path to reach their short, intermediate, and long-term goals. When analyzing one’s financial plan we will often look at what might derail them from reaching their goals. One issue that we often see as a hindrance to reaching these goals is outstanding debt obligations.
With Interest rates rising, access to money is diminishing for borrowers. Right now may not be the best time to finance purchases or refinance any outstanding debt. Although most Americans carry some sort of debt whether it be a mortgage, student loans, or consumer debt/ credit card balances, outstanding debt can be a heavy weight to carry.
There are examples of “good debt” and “bad debt”. A good debt may add value to one’s life, such as a mortgage, student loan, or incurring business debt. These debts are taken with the hope that in the future they may add additional value or income at some point. A bad debt will take away from one’s net worth and is used to purchase items that lose value over time and will not contribute to income. Bad debt generally comes with high-interest rates that will cost more money out of pocket. Forms of bad debt may include, revolving debt/ credit card debt, auto loans & personal loans.
When paying down outstanding debts, whether good or bad, there are a few techniques that one can utilize to increase efficiency.
One method of debt repayment is the snowball technique. With this method, one focuses on putting excess dollars into smaller balances and paying these off first while making the minimum payments on others. Once these smaller debts have been paid, the amount that was being paid towards this would be reallocated towards the next smallest debt. This method builds momentum, and like a snowball rolling down a hill, one can focus on smaller balances and eventually will be able to have the excess cash flow to reduce larger obligations. This is a way to build encouragement when repaying debts by achieving small wins.
The avalanche technique takes a similar approach but focuses on debts with higher interest rates. This strategy may take longer to eliminate the first debt but can save borrowers in interest over time. By focusing on the highest interest-bearing obligation one might save on interest charges and or fees. This will eventually free up cash flow to put towards other obligations or goals.
When financing a purchase, borrowers are taking dollars away from their future selves, by spending money they have yet to earn and eventually have to repay. This results in a reduction of future cash flow by promising to repay the institution that loaned funds to make these purchases. Implementing a savings plan is the best way to make most purchases, but sometimes waiting to save is not an option. Utilizing debt as a tool isn’t necessarily a bad option, but it is something that should be considered and analyzed to ensure that it is needed and will add value in the future.
Utilizing credit and incurring debt should be used as a tool to reach one’s goals but can become a slippery slope if not managed correctly. Implementing a budget and building an emergency fund is one way to avoid financing those emergencies one cannot foresee such as a car or home repair. If you or anyone you know could use assistance in setting and implementing a financial plan or a debt repayment plan, The Normandy team is always happy to assist.
The CERTIFIED FINANCIAL PLANNER™ professionals and Certified Estate Planners™ at The Normandy Group offer serious financial insights for today’s complex world. By combining investment, tax, risk transference techniques and estate planning strategies we can help you to provide clarity to your goals. Contact us today for a complimentary consultation.
Derek Landis, CFP®
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