Being “financially independent” has a few requirements to it. Those who are financially independent do at least two things well. They know how to manage their debt (#1), so that their credit is excellent (#2). Those two abilities go together, so we will address both in this discussion.
Managing Your Debt.
There are a few very easy simple steps to get out of debt. The first step we discussed in an earlier article: “Creating a Budget.” The rest of the steps are as follows:
Let’s say you have four different debts not including your mortgage. (Mortgages are a different discussion.)
- A car loan for $25,000, 6 years at 8.5%. Minimum payment $445
- An education loan $30,000, 25 years at 3.5%. Minimum payment $150.
- A credit card debt of $9,500 at 14.5%. Minimum payment of $122.
- A credit card debt of $10,200 at 9.5%. Minimum payment of $96.00
Notice that the total of the minimum payments is $813.00. (If you input the numbers, you will see that in every case I rounded up. If the payment is $145.18 pay $146. It is small, but it helps.)
Do not make only minimum payments. Assign a number as large as possible to your debt payments. In this example I am going to say that we are paying down this debt with $1,175 a month. So, in this case the extra amount over the minimum payment is $362.
Pay the highest interest rate debt first
Take the highest interest rate debt and pay it off first. In this example #3 is at 14.5%. The minimum is $122, plus the extra of $362 is a total of $484. Pay the minimum on all the other debt.
Debt number three will be paid off in approximately 23 months. Provided you put no other debt on the card. If you put any additional charge on any of the debts you need to add that whole charge, in the month of the charge, to the minimum payment. Otherwise your debt payment plan will not work.
At the end of 23rd month debt #3 will be paid, (provided there are no other charges or fees etc.)
Debt #4 will be down to approximately $9,834. (It is amazing how slowly credit card debt goes down. They really do want you to spend more and not think about how much they are taking from you.)
Take the entire $484 from the previous paid off debt, add it to the minimum payment on Debt #4 and you have a payment of $580 a month. Apply that every month the $9,834 on debt #4 and that debt is paid off in about 19 months.
When one debt is paid off, use these funds to pay the other high interest rate debt.
Repeat the previous step for Debt #1, your car. You will have made 43 months of payments on the car. Leaving two years and 5 months of payments left. You will have about $12,900 left on the car loan. Add the $445 car payment to the $580 a month from the debt payments on the first two debts (now paid off!) and you have a payment of $1,025 a month. Your car will be paid off in 13 months or about year and 4 months early.
Repeat with the remaining debt until paid.
NOTE: since the rate on educational debt (especially older educational debt) is low, there is an argument to be made that a slower payment is justified. For example: if your 401-k matches 50% on the first 5% of pay, that is a 50% return on your money. Greater than the 3.5% cost of the educational loan. Use some of the extra money being paid on the educational loan on your 401-k if you are not taking advantage of the whole 5% of salary match.
During this time, without realizing it you have also increased your credit score!
- First, you paid off your debt on time…. Better credit rating.
- Second, you paid off your debt early…. Still better credit rating.
- Third, you paid down your credit so your unused credit rises…higher score again!
Credit Scores are simple to understand and complicated to do. But, done carefully they are easy to build and easy to keep high provided you pay attention. The following are some of the parts of your credit score:
- Your income
- The amount of all your credit/debt
- The amount you pay in debt
- The amount of remaining credit you have not used.
- The length of time you have had each individual credit card
- The length of time your payments have been on time.
- Have there been any “charge-offs” or bankruptcy’s?
- How long have you been on your job?
- Is your income consistent?
There are more parts to the score but let’s just say it takes a great deal into consideration.
It is easy to say, “If I had a lot of money, my score would be higher.”
That is not always the case. You can have a very good score on a lower income, and a very bad score with a higher income.
Pay off your cards at the end of the month for better credit
Teach yourself to use credit this way. First, get a debit card. This is a credit card that you must put money into to use. Learn to use it. Learn not to try to take money out when there is no money there. Believe me they won’t let you. Teach yourself to be so aware of what is on the card that you don’t ever get turned down when using it.
Next, try American Express. I like them because you must pay them off every month. There is a fee, but it is worth paying it to have the restriction of paying off your expenditures each month. Once you have mastered your use of and payments on both the debt card and the Amex get revolving Mastercard or Visa. Don’t throw away the other two as the length of time you have had a card, used well, adds to your positive credit score.
Master those three cards: debit, monthly pay in full (Amex) and one revolving MC or Visa. Use them well. Pay all your utilities, rent and phone on time or early. Stick to your budget.
