Getting out of debt: get organised and use the Snowball system
We accumulate debt for various reasons. Sometimes people fall on hard times for reasons beyond their control; sometimes it’s just from overspending, we live in a day and age of instant gratification – we see something and we want it – so if we don’t have the money to buy it we put it on credit.
If we repeat this habit over time, it quickly adds up to lots and lots of monthly payments and then it gets to a stage where we don’t want to open our bills because we’re scared of what’s inside.
And then we don’t know how to get out of this mess, we feel trapped and don’t know how to solve the problem of paying our debt off and getting our life back.
But facing up to it is essential if we’re to do something about our debt.
The first thing to do is to stop the habit: stop overspending. If we refer back to The Money Plan, Step 2 is about getting financially organised – knowing what comes in, what goes out, what you owe and what you own. We need to be organised to know this.
You can download a debt organiser spreadsheet for free in the resources section of this site. This will let you put all your debts, income and expenditure in a clear format that will help you get control.
Once you know what’s coming in and going out, it may have surprised you or it may just have solidified what you already knew subconsciously but didn’t want to see on paper.
But what do the numbers look like; is there a surplus of income over expenditure? In The Money Plan we talk about paying the first hour of any working day to yourself, that’s 12.5% of your gross income, which we use to pay down unsecured debt.
After you’ve looked at what’s happening, if there isn’t a 12.5% surplus then you need to do something to create one. There are two ways you can go.
The first is to make some cuts in your expenditure. There are all sorts of ways to do this: satellite TV subscriptions and having top of the range mobile phones are two typical examples; also have a look at utilities, which can be negotiated, and make sure you’re paying the lowest possible price on any insurances you take out by using comparison sites.
The second option is to increase your income. Using payment clubs like Top Cashback and Quidco can give you rewards on your normal shopping habits, and voucher sites like Voucherco.com can help too. You might also look at getting a part-time job to bring in extra money, which can potentially all go to paying down your debt faster.
However you do it, you really need to make sure that you have 12.5% of your gross income going to you to help you pay off your debt, that’s one hour of an eight-hour working day.
Next, we look at our assets and liabilities. Let’s face it, If we’ve got money in bank accounts earning less than 1% and also have high-interest credit card debt, we should take the money and pay off the debt.
I personally think you should have at least a minimum of £1,000 in reserve, but other than that, any other money you have elsewhere, you’re better off using it to pay down the debt with current interest rates.
You can also look at things like reducing the rates of interest that you’re paying. Interest free credit cards, lower rates of loans, that kind of thing. Take a look on the Money Facts and Money Supermarket websites, there are lots of comparison sites out there. On the free organiser spreadsheet there are links to different providers to see if you can save interest elsewhere.
What we’re trying to do is increase money coming in and reduce money going out, and then on the debt side of things trying to make the interest or cost of that debt as low as possible.
I’m not a huge fan of consolidating all of that debt into one, as long as you’re organised there are no disadvantages to keeping a number of loans or cards, all you’re trying to do is keep the payments down as low as possible.
Paying off your debt: the Snowball system
Now you’ve got a clear understanding of what’s going on, you need to organise those debts on your spreadsheet in order of balance: smallest first, through to largest balance. Ignore the interest rates, just order them by balance from low to high. We’re now ready to use the Snowball repayment system.
Here’s how it works: you pay the minimum payment on each card or loan you have, and then pay a larger sum of money – your extra 12.5% mentioned above, all your surplus – onto the smallest balance. All our focus and attention is going on paying that smallest balance off.
Why? To get a quick win. Psychologically, we want to get a dopamine boost. We get that smallest balance paid off as quickly as possible by doing anything you can to get it paid down, and you’re going to feel really good about it.
Once that first one’s paid down, we carry on paying the minimums on all loans and roll over our surplus to the next smallest balance, and we repeat this over time. Now we’re focused on getting rid of what was the second smallest balance when we started out.
It takes months, not weeks to pay off debt, especially if your credit card balances are quite high, but this system gives you momentum, and you’ll see your balances reducing very quickly.
From here, you keep your spreadsheet up to date, you review it once a month when you get paid, and you keep things organised. Remember not to deprive yourself of everything; you still have to enjoy life, and complete deprivation of fun is not the right way.
I appreciate paying off debt is easier said than done. It’s emotional and when you’re in debt it can feel like there’s nowhere to turn. But step 1 has got to be to get organised. Let’s be brave, get the information out on the table. Complete the spreadsheet and it will even calculate when your balances will be paid off, so you can see just how quickly that first debt can be gone.
Technically it would be more advantageous to pay off the highest interest rate first, but the challenge is that if that’s your highest debt then it will take a long time to pay it off and psychologically you’ll start to feel disheartened. There’s a strong chance you’ll feel it will never be paid off and you’ll potentially give up. Instead, we want to get you that first quick win, that dopamine scooby snack as I like to call it, which comes with paying off one of your balances.
This another advantage of not consolidating – you can’t get these same boosts along the way.
Take a programmed, organised stance to paying off your debts. Don’t use your credit cards again – what they are is effectively debt cards – and unless you are extremely disciplined with money, you don’t need to use debt cards. Don’t tempt yourself, cut them up and bin them.
I respect that debt repayment is an emotional journey, not usually a logical one, so connect with me and I’ll walk that journey with you. This is about long-term planning, not a quick win, and I’m here to help.
Minimum payments: be aware
While the Snowball system advocates keeping on minimum payments for all but your smallest balance, beware of doing this over the long-term if you’re not using the system. The numbers are shocking when you delve into them.
Let’s say you have a balance of £3,000 at an average interest rate of 19%, if you only pay the minimum payment on your credit card it’s going to take you over 20 years to pay that credit card off and the amount of interest you pay is going to be over £4,000!!
That’s because as the balance drops, so does the minimum payment required. In the above example, it would likely start at around £74, and go down from there.
But if instead you keep the payment the same every month it massively shortens the repayment terms and reduces the interest you pay. In this case, if you paid £74 every month instead of the minimum, you’d pay the debt off in five years and the interest you paid would be nearly three times less.