How to Reduce Debt and Develop Success Habits for Wealth Management - dummies

How to Reduce Debt and Develop Success Habits for Wealth Management

By Dirk Zeller

To reduce debt, you first must eliminate your consumer debt by paying off your credit cards. From there, your path to financial success depends on smart wealth management through a “wealth plan.” Start your path to financial freedom by eliminating any existing consumer debt with a debt payoff plan.

Reduce consumer debt

Consumer debt must be avoided if you want to achieve wealth, financial success, and ultimately financial freedom. Consumer debt includes credit card debt, consumer loan debt, retail store or gas credit cards, revolving accounts, and even car payments. It’s any debt you would take on for consumption purposes. Any debt entered into on a non-appreciation asset should be questioned. So, what about a car loan? A car is a depreciating asset. The car loses value the minute you drive it off the lot and continues to depreciates in value over time. But the use of loans to buy cars today is commonplace. In fact, 43 percent of the adult population has a car loan to pay. In the 1960s and 1970s, it was rare for people to have car loans. If you want to join the ranks of the wealthy, avoid bad debt and consumer loan debt.

Now the use of debt on appreciating assets is a valid tool to create and increase wealth. An appreciating asset could be the home you live in, an investment property you purchase, or business that you acquire.

By and large, an appreciating asset with reasonable debt amounts will help you create more wealth. The desired wealth needed to achieve financial independence influences the need to use debt as a tool.

The type of debt that more than 65 percent of all Americans have is consumer debt: bad debt, and much of it is credit card debt. Most people, no matter their background or knowledge, have at one time or another had problems with consumer debt. Successful people don’t avoid mistakes; they make the mistake only once and learn from it.

You can use some strategies to create efficiency and value in using credit cards sparingly and well. And there are ways to get out of credit card debt efficiently and permanently.

Reduce credit card debt to build wealth

If you presently have credit card debt, you need to work out of that situation. This non-deductible debt, in my view, is the worst form of debt. When you combine that with the high interest rate that credit cards usually charge, it really is an explosive problem. Putting the credit card down and not using it is certainly the best strategy.

Maybe you have some ongoing business needs or personal needs that require a credit card. Most business service providers will take an EFT charge direct from your account. If you have a credit card with a balance that you cannot pay off, and you need the use of your credit card for some reason, here are a few steps you must take:

Step 1: Resolve to pay all new charges off in full on time

If you carry a loan balance on a credit card, when you charge something to that specific card, large or small, from the moment of the charge processing, you will accrue interest charges. The interest rate is obviously incredibly high. No one ever got wealthy paying 17-percent interest to someone else. The normal 25-day grace period to pay with no interest charged is gone. Because of the balance on the card, you will be paying interest from the moment you bite into that hamburger you just charged. It means that $15 lunch will cost you 17 percent more!

Step 2: Establish a going-forward credit card

What you need to do is pay off one card that will be used as your going-forward credit card for emergencies and necessities. Reread that sentence: The key words are emergencies and necessities, not discretionary spending.

You want any balance moved to a very low-interest card or credit line. Frequently, if you have good credit, you will receive offers with a 2- to 5-percent one-time fee on the balance you are transferring. You then can receive 12 months with no interest to pay it off. It’s not no interest, because you paid the 2- to 5-percent fee upfront, but it’s a lot better than 17 percent interest ongoing month to month.

The key is that you must use a credit card with zero balance as your emergency need card. And you won’t ever use that emergency need card unless you have the ability to pay the full balance each month. Your goal is to only spend at all times what you can comfortably pay off each month. And if you have to transfer a balance to a spare credit card and pay the one-time fee of 2 to 5 percent, do it. Then budget out paying off that card in the timeframe of the zero-interest year. The worst thing you can do in this strategy is run up debt that you can’t pay off monthly. You will be in even more debt than before.

Do the math of figuring out how much you need to pay each month to erase your debt in the specified time. Then pay that specific amount, or just a little bit more. That way you are only paying 2- to 5-percent interest on the transferred borrowed amount.

Again, do not charge a thing on this card. The credit card companies apply payments to the lower interest rate balance owed first. The only thing that you will pay for is the annual fee charge if any. That will be charged at your normal interest rate charge. Get yourself out of credit card debt as quickly as possible by paying the lowest rate possible. Then never go back into credit card debt.

Develop a successful debt payoff strategy

There are a number of systems to help you control and get rid of credit card debt. The key is getting out of high-interest, non-deductible consumer debt.

If you are in debt you must create an organized strategy to retire that debt. I have created and included a tool, shown in this figure, from our Champions of Wealth course for your use. This Debt Management tool looks at your number of credit cards. It helps you organize your debts and set a strategy to become bad-debt free.

The tool provides you a place to simply organize and list all your debts completely. You will want to just brainstorm and fill out the form. List everything on the document rather than organize as you go. Don’t evaluate based on an amount or interest rate. The purpose is to just create a complete accounting in one spot of all debts you owe. The debts you have will become easier to organize a plan for once you have identified and collected them all in one document. List all bad debt first.

Debt management tool
Debt management tool.

Picking your debt payoff plan

Now that you have your list of debt, you need to craft a debt payoff plan to get rid of it. It will be hard to invest and save at the level you need to without getting out of debt. There are two schools of thought in the strategy of paying off debt. One school is the financial strategy for debt reduction and one is more of an emotional strategy to pay off debt. There is not a quantifiable best option here, so choose what’s best for you. The financial strategy goes back and organizes your credit card debt cost based on interest rate. You list your highest interest rate debts at the top, pay the minimum payment on all other debt, and power excess funds in paying the highest interest rate one first. That strategy makes greater financial sense, but it might not be right for you. In fact, it might not be correct for most people depending on whether you can create momentum and feel good about the progress you’re making in getting out of debt. Maybe your highest interest rate debt is also the largest amount. It takes a greater discipline to pay debt off through this method.

The emotional strategy that has the highest likelihood of success is tackling the credit card or debt based on amounts. You organize your debt based on smallest amounts at the top. This way you start to see progress sooner. The strategy of ranking which to pay off is based on the principle of momentum and positive progression. This way creates emotional excitement and rewards sooner and more consistently. The goal is paying off the card and then cancelling it forever. This is especially true for store credit cards.

Store credit cards carry the highest interest rates. They also have the enticing money-saving offers. We shop at Old Navy for my kids. Every time, they offer a credit card where I can save 15 percent off our total purchase. If we are spending a few hundred dollars, it’s $30 to $50 in savings. Let’s be honest, a good deal is enticing to any of us, but I always turn it down because my time of having to deal with another credit card is just not worth the one-time savings.

The goal is to reduce debt, reduce expenses, and hassle. Every card you carry has an expense, usually an annual fee, and the hassle of dealing with more bills and tracking. It’s just not worth the one-time offer in savings.

Laying out your GALP (Gone After the Last Payment) plan

What you want to do is base your strategy on the Gone After Last Payment system, or GALP. Pull together your statements and balances and then calculate your GALP number. Take the outstanding balance and divide by the minimum payment to determine how many months it would take to pay off the credit card or debt. The goal is to pay more than the minimum so that you do it faster. You also have to recognize that if you only pay the minimum you won’t have it paid off in the GALP number because you are not factoring the interest charged each month you will pay, but you will be close. Take a look at the following table, which shows a sample debt scenario.

A Sample Strategy for Debt Payoff
Account Outstanding Balance Monthly Minimum Payment GALP Number GALP Ranking
VISA $550 $50 11 1
MASTERCARD $720 $60 12 2
AMEX $1,400 $40 35 3

At a minimum, to hit your GALP number, you have to pay the minimum payment plus the accrued interest that the bank is charging you. Only then can you pay off and close the account out of your GALP number. Then you add the snowball concept: After you pay off a card, you then add what that payment would have been to your next debt plus the minimum payment and accrued interest. You then start paying that card down and just continue repeating the process until all debt is gone.

Laying it out on paper (see the following figure) and tracking your progress is a powerful way to create excitement and momentum. It’s a way for you to save the money you need to create the wealth you desire, and fund your present and future lifestyle.

GALP tool
The GALP tool.