Becoming debt-free faster with the ‘debt avalanche’ method
With the combination of the festive season and the recent spike in interest rates squeezing budgets, addressing the level of debt is becoming a priority for some. Whilst assets that generate income can be legitimately financed by debt that is tax deductible, having a plan to reduce the burden of any personal debt should be a key priority.
One strategy to become debt-free faster is to employ the “debt avalanche method”. It can be tempting to pick out one debt such as the mortgage and choose to view progress on reducing that debt as the benchmark for success. However, a better method is to minimise the amount of money being paid to the bank and maximise the amount of money available in your wallet by looking at all of your different debts together and making a debt reduction plan.
The first step is coming up with a budget. You need to work out much income you bring in and how much you spend. Anything left over is your ‘net savings’. If you spend more than you make then larger behavioural changes will be required, such as finding ways to earn extra income or cutting back on some of the finer things in life. When people ask “what is the best kind of budget to have?” the answer is the same as “what is the best kind of exercise?”. The best option is the one that you will actually stick with. You can come up with the most aggressive exercise regime in the world but if you don’t stick to it then you will not get any fitter. Likewise, when it comes to a budget, if you cut out all the things that you enjoy in life, you will get sick of being tyrannised by yourself pretty quickly and then find yourself ignoring your new budget entirely.
A budget should not be something you dread. It is a tool which can allow you to clearly see the building blocks you have available to build your financial future. The key here is coming up with a balance between living a lifestyle where you don’t feel deprived and making progress towards your financial goals. Once you have a budget in place which allows you to have a cash surplus every year, it is time to build an emergency fund of 3-6 months’ worth of yearly expenses. This will protect you against the pitfalls of life that will inevitably arise such as your car breaking down or having a family emergency.
Without an emergency fund these types of events can turn your life upside down and be major sources of stress. With a fully funded emergency fund these are merely short-term setbacks. With an emergency fund in place, you can now begin to tackle your debts. List all your debts smallest to largest with their associated interest rates and put your entire ‘net savings’ into paying down the debt with the highest interest rate. As the debt gets paid down use the money that was going towards those interest payments to pay off more of that debt’s principal. Once the highest interest rate debt is paid off move on to the next highest interest rate debt. As you pay off these debts your households net savings will grow and with that extra surplus you can increase the speed at which you will get out of debt. This is what is known as a ‘debt avalanche’.
