Last week we talked in this space about debts and how important it is to get out of them, because many times they generate strong financial stress in the family and they are also the main cause that prevents people from building wealth. By having part of our future income already committed to paying for something we bought long ago, we have less savings capacity and less financial flexibility to think about other things. In addition, many times debt is a symptom that we are living a life beyond our means.
That is why getting out of debt and putting an end to that vicious circle, to turn it into a virtuous one (turn our situation around), is such an important goal in the short and medium term for many people.
If we have decided to do it, as we mentioned in last week’s columns, the first thing is to stop using credit cards and even stop thinking about asking for credit. I mention it because, ironically, many people think that the “solution” to their debt problem is to request a new credit “to consolidate them into one.” I have seen first-hand many times how the remedy is worse than the disease, because many fall into the same pattern: they paid off their cards with that new credit, little by little they begin to use them to face irregular expenses or to get out of trouble and end up more in debt than before.
Then we have to start taking control of our money little by little through a well-done spending plan, as we described last Thursday. Keeping in mind, of course, that the priority is to get out of debt, but also to prepare for future irregular expenses in such a way that, when they arise, we can pay them in cash (instead of increasing our debt or taking a step back).
Now, if we have more than one loan, it is important to focus on attacking –liquidating– one of them, obviously keeping all the others up to date. This means: pay the bare minimum on all, but allocate whatever additional resources we can, to getting out of our smallest debt.
Why focus on the smallest and not the most expensive? It is true that from a strictly financial point of view the latter would be the most appropriate, but it is not what works best for most people.
We choose the smallest one to get out of it as quickly as possible. That gives us great motivation to continue down that path. Feeling that we are winning is very important.
When we finish with it, then we can attack the next one in size and so on until we finish.
Obviously this strategy can be adapted a bit. If I have two cards and I owe 14,000 pesos on one and 15,000 on the other – but the interest rate on the latter is significantly higher, given that the amount is relatively similar, we will have to go for the more expensive one. It’s about being smart in applying the strategy.
Of course, any strategy to get out of debt implies, as we have already said, having the ability to make at least the minimum payments on all of them. There are no magic solutions. If we’re already having a hard time doing this, we’ll have to consider selling some of our stuff so we can wipe out our smaller credits right away.
I know it’s not nice, but sometimes it’s necessary. It is responsible and it is also a way of learning that debts often destroy wealth instead of building. Instead of helping us grow, they take us away. On the contrary, when we are debt free, we will have the flexibility to use all of our disposable income to achieve what is really important to us in life.
Personal Finance Coach
Heritage
Senior executive in insurance and reinsurance with strategic business vision, high leadership, negotiation and management skills.
He is also a Personal Finance columnist in El Economista, Personal Finance Coach and creator of the page www.planetusfinanzas.com