The other day I was talking to some friends about finances (yeah, these are the kinds of conversations you start having after age 25…) and one of my friends whose debt was spread out over a lot of different loans started talking about his strategy:
FRIEND: So basically I’ve got these two student loans and I usually pay an extra hundred bucks on one of ‘em and an extra fifty on the other, and then I’m also trying to pay off my car so sometimes I pay some extra there, but then every once in a while I get some money on credit cards too so I throw in a few bucks to cover that….
This is a textbook example of how you SHOULDN’T be dealing with debt. I talked about this a little bit last fall after I paid off one of my student loans, but here’s an expanded version:
Pinpoint and Pay
By far the best method for paying off debt is the Pinpoint and Pay Method, which works like this:
- Stash away a savings/emergency fund. This will stop you from taking on extra debt and making things worse. The amount of your fund is going to look different for everyone, but try shooting for either $1,000 or 3 months pay depending on your situation.
- Pinpoint a single piece of debt you want to pay off first.
- Each month, after paying all your bills, put any leftover money from your budget toward this one piece of debt.
- Do this until that piece is gone.
- Choose another piece of debt and repeat Steps 3 & 4.
- Celebrate how awesome it is to not be in debt anymore.
Pinpoint and Pay Has Some Distinct Advantages…
Unlike my friend who was spreading his extra money all over the place, Pinpoint and Pay helps you focus on a single piece of debt until it’s completely paid off. This not only helps you get results faster, it also turns bill-paying into a simple, easily repeatable system instead of a haphazard free-for-all of throwing money at random bills and getting overhwelmed.
Paying off debts (even small ones) not only gives you extra money every month, but it makes you feel accomplished for having achieved your goal, which leads to positive energy that you can carry into both your working life and your creative life. (And you know I’m all about that positive energy!)
Having an emergency fund is important too, since a backup cache of money can be a lifesaver when your car breaks down or you need to buy a new suit for a job interview or you need extra cash to cover your creative expenses. Without an emergency fund, you’ll be stuck putting these unexpected expenses on credit cards, adding new debts to the mix and setting yourself back. (This blogger explains the logic behind this pretty well if you’re interested.)
That initial saving process can be daunting at first, especially if your debts are stopping you from stashing money away. If you’re stuck between a rock and a hard place, try looking for ways you can live more frugally, or check out this list of less less intimidating ways to save.
But Ian, Which Debts Should I Pay Off First???
Ah yes, the age-old question. The path to financial freedom is going to look different for everyone, but in general there are two paths you can take. Both have their advantages, but whichever one you choose, stick with it and keep going—don’t spread yourself thin like my friend in the example
Pay Off Lower Principals First
This is my usual method. The smaller the principal (i.e., the total amount of the debt), the faster you can bring it down to zero, which means one less bill to pay every month. This in turn means more money to spend on other things, including paying off your next piece of debt, thus creating a snowball effect where you can pay off your other debts even faster.
This method’s most useful for people who are looking to make a life change but need to free up more cash every month to make that happen. Also, never underestimate the positive effects of reducing clutter and draining those debt balances down to zero—it helps you stay positive about your debt management!
Pay Off Higher Interest Rates First
Not for the faint of heart, this path is the black diamond of debt-paying. Higher interest rates on some loans means you’re paying more money in the long run, so draining these higher interest debts by even a little bit means they’re going to accumulate a lot less interest over time, and thus help you pay everything off exponentially faster than if you’d waited.
The extreme advantage of pinpointing higher-interest debt is that you’ll be paying less money in the long run (good for all the Day Jobbers out there with long-term goals!), but the disadvantage is that it leaves you tied into that plan with more payments eating up your cash flow.
Why Is This Important Anyway?
Debt’s real and affects all of us. One survey I found indicated that 25% of Americans listed their primary goal as simply to get out of debt. Americans in 2016 finished college with an average of over $37,000 in student loans, and if you look at the total average loan debt for all students across the country, my home state of New Hampshire tops the list with $36,101 per student. (Boooooooooooo!)
Debt can be a major obstacle that keeps you from achieving your goals, whether it’s to buy a house, write a novel, visit Iceland, or move to New York and start an acting career. All those things become a lot easier if you have money saved, and saving is way, WAY easier if your monthly income isn’t being drained by a bunch of loan payments.
For me, getting rid of debt is about having to work less: the lower my debt, the lower my monthly expenses, which means I have to work fewer Day Job hours to cover those expenses. This leaves me with more time to focus on my creative work and on blazing a new life path that doesn’t involve a Day Job at all, which is the goal I’ve been shooting for all along.
Thus: Less Debt = More Freedom