Simple Tips for Financial Freedom – PART 2

Welcome to PART 2 of Simple Tips for Financial Freedom! If you missed PART 1, check it out here.

The key to having financial freedom is to get your money to a point of positive cash flow. If you are making a decent income but you still live paycheque to paycheque, it is because you have negative cash flow

Cash Flow is an accounting concept, but it can be illustrated simply, as follows:

Incoming Cash (Paycheques) – Outgoing Cash (Bills & Spending) = +/- Cash Flow

Many people think that they just need to make more money to get ahead. This often backfires, because as their income increases, people tend to spend more money and take out bigger loans. Here are my tips for pulling yourself out of that negative debt circle!

Don’t buy a home that will make you “house poor”. 

There is a great divide between what the bank will allow you to borrow and what you can reasonably afford. A standard affordability metric is that you should only be spending 35% of your income on housing costs (including utilities, home insurance, and property tax). Here is a fun/depressing mortgage affordability calculator! The term house poor refers to the situation where a person has over-extended their personal budget to buy a house. Someone who is house poor may appear to others to be doing well financially because they have the trappings of wealth, but they are probably struggling to pay other bills because they are up to their neck in mortgage payments. Just because the bank will lend you X dollars, does not mean that you should borrow X dollars. When you are shopping for a house, determine what your budget will be beforehand and then stick to it unequivocally. Don’t even view houses that are over your budget because you will be tempted to go over!

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My 1st house was the cheapest on the market! What, you mean, yellow and brown does not say “curb appeal”?

If you get a chunk of unexpected money, put it against your debt.

I know, I know. This one is awful! It’s painfully boring, but if you are serious about getting out of debt quickly, you need to put any “extra” lump sums against it. Maybe your employer gives you an annual bonus or you get a tax refund: pay that against your debt right away. Think of it this way, that money wasn’t part of your regular monthly budget so you aren’t going to miss it! Paying monthly amounts against debt is great, but its a very slow process, so you can really speed up the timeline with lump sum payments. If you absolutely cannot stomach paying the full amount, set aside 10% and allow yourself to buy a special “treat” with that. This one sucks in the short term, but it will be worth it over time.

Pay off the highest interest loans first – The Debt Avalanche Method

Once you’ve sorted out your monthly budget, determine the maximum amount that you can put towards your debts in a month. Next, order your debts by interest rate from highest to lowest (exclude a mortgage) and indicate what the minimum required payments are. If you don’t know the interest rates you are paying, now would be a good time to find out those details.
Here is a sample situation:

Personal Line of Credit 21% – Minimum payment $0
Credit Card 19.5% – Minimum payment $100
Auto Loan 7% – Minimum payment $300
Student Loan 5.5% – Minimum payment $150

Let’s say in this example, you had determined from your monthly budget that you could afford to pay $800/month against all debts. What you would do is pay the minimum payments on everything other than the highest interest rate debt. Attack that high interest loan with the largest payment you can! This is called the Debt Avalanche Method, which I prefer because you will pay the least amount of interest over time. Another option is the Debt Snowball Method (see infographic below) and this may be preferable if you know that you are a person who needs to see a quick return to be motivated to follow through with something.

Student Loan Infographic

Let’s see how that avalanche goes!

PHASE 1:
Personal Line of Credit 21% – Pay $250
Credit Card 19.5% – Pay Minimum payment $100
Auto Loan 7% – Pay Minimum payment $300
Student Loan 5.5% – Pay Minimum payment $150
TOTAL $800

Now this is where the magic happens! Once that Personal Line of Credit is paid off, you continue to pay $800/month but redistribute the maximum to the next highest interest rate loan.

PHASE 2:
Credit Card 19.5% – Pay $350
Auto Loan 7% – Pay Minimum payment $300
Student Loan 5.5% – Pay Minimum payment $150
TOTAL $800

PHASE 3:
Auto Loan 7% – Pay $650
Student Loan 5.5% – Pay Minimum payment $150
TOTAL $800

PHASE 4:
Student Loan 5.5% – Pay $800
TOTAL $800

BOOM! This strategy will pay off your debts the fastest and will result in paying the least amount of interest over time! You can set the payments as automatic bill payments in your online banking to help you stick to the schedule you’ve created.

Focus on the big picture. 

It can be very difficult to stick to a debt repayment plan if you are watching people around you go on vacations, buy new vehicles, and nice homes. It may feel like everyone else has more money than you, when in reality, they probably just have more debt than you.

People often say “money can’t buy happiness” but how many people’s actions follow that sentiment? 

I’ll tell you what does bring happiness: less stress and more time spent with the people you love. Be grateful for what you do have and focus on your goals and dreams for the future. Imagine what it would feel like to go on a vacation that you had saved cash for, and to not be fighting with your spouse about the credit card statement, and to drive around in a car that was fully paid for. It will be a struggle and you will have to make sacrifices, but it will be worth it.

Notice that I didn’t title this article Simple Tips for Financial Success. It’s called Simple Tips for Financial Freedom, because that’s how I feel.

FREE.

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One thought on “Simple Tips for Financial Freedom – PART 2

  1. Pingback: Simple Tips for Financial Freedom – PART 1 | Coastal Tax and Accounting Services

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