Steps to Financial Freedom, Part 2

13. December 2008 by admin.

Thanks for joining me again as I discuss the steps to financial freedom. I’ve gleaned this information from Dave Ramsey’s great book on personal finance “The Total Money Makeover.” As I wrote in an earlier post, the seven steps to financial freedom may take at least seven years.

“That’s a long time,” you say.

But just think about where you will be in seven years if you don’t take steps today - that should be motivation enough.

Step 2: Pay Off All Debts Except Your Mortgage.

“Whoa!! What do you mean pay off all debts except my mortgage?”

I mean pay off all debts except your mortgage.

You glance at your piles of bills and think: That will never happen.

Take baby steps. A journey of a thousand miles begins with one step.

First, gather all your bills in one place. Then make a list (preferably on a spreadsheet) of everything you owe. List the total debts from smallest to largest along with the minimum payment for each debt.

Here’s the fun part. Every month, make the minimum payment on each bill except for the debt with the lowest total balance. With that particular bill, add whatever amount you can afford to the minimum payment every month. This additional amount will help pay down the principal for that debt. (Principal is the balance you owe on a debt, minus the interest charges you pay to borrow.)

When you pay off the smallest bill, take the amount you were paying towards that and add it to the principal payment of the debt with the second lowest balance.

Huh???

Here’s an example:

Jane got tired of all the creditors calling her. After saving her $1,000 in cash (she was sooo proud of herself), she decided it was time to get the debt monkey off her back. She gathered up all her bills. They were scattered all over the house: under her mattress, stuffed in the potted plants…torn up into shreds and used as cat litter.

Jane discovered she owed the following:

Creditor 1: $500 Minimum Payment: $15
Creditor 2: $900 Minimum Payment: $25
Creditor 3: $4,000 Minimum Payment: $100
Creditor 4: $18,000 Minimum Payment: $250
Creditor 5: $46,000 Minimum Payment: $450

After paying all her monthly utilities, rent, food, and gas, she had about $20 left each month that she could add to Creditor 1’s principal payment. So every month, she pays Creditor 1 $35.00 in addition to making minimum payments for Creditors 2-5.

Her monthly payments look like this:

Creditor 1 Minimum Payment: $35
Creditor 2 Minimum Payment: $25
Creditor 3 Minimum Payment: $100
Creditor 4 Minimum Payment: $250
Creditor 5 Minimum Payment: $450

Total Monthly Payments: $860

After months of discipline and consistency, she pays off her bill to Creditor 1. Yay!! She then adds the amount she paid to Creditor 1 ($35 per month) to her Creditor 2 payments. It now looks like this:

Creditor 2 Minimum Payment: $60
Creditor 3 Minimum Payment: $100
Creditor 4 Minimum Payment: $250
Creditor 5 Minimum Payment: $450

Total Monthly Payments: $860

When she pays off Creditor 2, she rolls that pay over to Creditor 3. Her monthly payments now look like this:

Creditor 3 Minimum Payment: $160
Creditor 4 Monthly Payment: $250
Creditor 5 Monthly Payment: $450

Total Monthly Payments: $860

And so on.

Notice that the Total Monthly Payments never increase, they are just rolled over to the next creditor. And it all started with adding just $20 to your regular monthly payments..easy peasy.

You must be consistent and focus only on paying off all debts (except your mortgage) until you wipe them out. Don’t try to straddle your money between investing and paying off debt. Make this a focused debt payoff effort, like a laser beam.

Another key is: DON’T ADD ON NEW DEBT!!!! Cut up your credit cards, stick them in the freezer, close your accounts, tie your hands behind your back at the mall ( or better yet, avoid all retail temptations). But do not add on new debt.

I welcome questions specific to your situation. So ask away..

Stay tuned for Step 3.

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