Debt Elimination Strategies

In this article I will be describing two debt elimination strategies that can be implemented with the Debt Accelerator software that I mentioned in my last article. The two strategies are the Snowball and the other is the Cascading Debt.


Snowball

1. Make a list of all the debts that you have. Include as information the current balance, the interest and the minimum monthly payment due.
2. Re-organize list smallest balance to largest.
3. Make your payments.
   
4. When the debt at the top of the list is paid add the payment of that now paid debt to the next debt on the list.
5. Each time a debt is paid repeat step 4.

Cascading Debt

The only difference is that the list needs to be organized from highest interest to lowest interest.

Mathematically the Cascading Debt is the method which saves the most interest however by using the Snowball you may see faster results which may keep you from giving up on this strategy.

The Accelerator

Is an extra amount of money that is added to the debt at the top of the list (for either strategy) to help accelerate the debt elimination. Obviously the greater the accelerator the greater the acceleration:) This makes having a budget to insure that the accelerator is maximized is very important.

My Numbers and Projections

click on images to view larger

Figure 1 Screen Shot My Numbers using Cascading Debt Elimination

Figure 2 Screen Shot My Numbers using Snowball Debt Elimination

Figure 3 Screen Shot My Numbers using my accelerator

Comparing the results of Cascading (Figure 1) to Snowball (Figure 2) we see that in both cases all debts would be paid in 14 years except that with the cascading strategy we save $151.81. This is negligible in my case but $151.81 is $151.81.

Figure 3 shows the power of the accelerator which in my case would allow me to pay off all my debt in 5.5 years! I know some of you reading this will say things like "Sure if I had $1950/month extra to put towards my debts it would be easy.". This would show a misunderstanding of the way debt works. The reason is that your creditors lend to you according to your ability to pay. This means that their may be among you that earn significantly more than me and have much more debt than me but have more money to put towards their accelerator and therefore could be debt free as fast as me, Of course the same is true for those that earn less. The exception are people who end up in a situation where there earning significantly decrease from when they made the debt.

John Commuta author of Turning Debt into Wealth ebooks asserts that for most people they should be able to pay all their debts including their mortgage in 5 to 7 years.

In my next article I will give you my view on debt elimination vs savings.

Importance of Debt Freedom

Two reasons for working towards being debt free:

1. The less debt one has, the less passive income is needed to pay for it. As shown in my last post, I need $1900.00/month of passive income just to make up for my debt obligation.
2. Money spend on debt can be used in investments which generate passive income. We all know that it takes money to make money. In my case, if I always make minimum payments it will take almost 54 years to pay my debts and during that time I will pay almost $222000 in interest alone!!!!

Imagine $222000 that could be better spent towards generating passive income will be gone! The worst part is that my total debt today is about $220000!

Can I have a show of hands? Who thinks that I am totally and utterly done for?

The good news is that there are things that can be done to help us back on the path to financial independence. The most important tool is an application I found, Debt accelerator. To give you an example of how useful this piece of software is, it shows me how with the same money that I spend today towards my debts can pay off the debts fully in 14 years rather than in 54 years and save just over $124000 in interest! That is money saved that can be applied towards investing in passive income stream.

This software even shows you the impact of applying a monthly acclerator to your debts. An accelerator is an extra amount that you budget to attack debt.

The strategies that Debt accelerator makes use of are known as cascading debt elimination and snow balling. I will explain these strategies in the next post.

How do you know when you are financially independent?

You can consider someone to be financially independent if they bring in more income from non-employment (passive) income than what they need. Of course 'need' can be a rather subjective word. Some of us need an expensive home theater system or expensive car, while others need remarkably little.

It is obvious that the more we need, the harder financial independence will be to achieve. In my case, my household expenses are $2400.00/month and $1900.00/month of debt. This means that in order to declare myself financially independent, I need to find passive income sources amounting to $4300.00/month!

I am lucky enough that I get rental income (passive income) of $775.00/month from my duplex, but this is gross passive income: before taxes and expenses. I'm going to estimate it as a net passive income of $500/month, which means that I still need to increase my passive income by approximately 900%.

I think what we are learning here is that the debt is keeping my dreams of financial independence further out of reach. If I could find a way of eliminating my debt obligation, I would only need to increase my passive income by approximately 500%.

At this point you may think that I am leading you on a predetermined path, that is because I am. I have actually started this path in September of 2007 and I really believe that debt is a big hurdle to financial independence.

In the next posts, I will discuss more about how bad debt is for your financial health, and techniques that can be used to eliminate it.

Journey to Financial Independence

How many of you reading this have wondered how can I achieve financial independence? What is the secret that alludes so many of us? Is it possible for the average person to set themselves up to be financially independent? Or is the deck stacked up against us?

If you have come here to have expert advice from someone who is financially independent ..... well, you have come to the wrong place. I am not wealthy and I am very dependent on my income as an embedded hardware designer.

The purpose of this blog is actually to try and find a path to financial independence for myself and to record the journey which I hope will lead to financial independence. I hope this blog can become a useful source of what to do and (hopefully not) what not to do.