5-Step Plan – Step 4 – Paying Down The Debt

If you’ve set up the first three parts of the five-step plan appropriately, you should have a clear path to success in front of you.

By now you have

  • A monthly budget that allows you to live within your means
  • A system for keeping track of your costs, giving you the tools to stick to your budget
  • An emergency fund with three months costs saved up, giving you a safety net in case anything should go wrong
  • An amount of cash left over after your costs each month, which you will be using to pay down your debt

You now have a long, hopefully fairly straightforward path to being debt-free in front of you. We just need to calculate how long it will take us, and engage a process of continuous optimisation.

Your Debt Paydown Plan

If you haven’t already, you should open the debt repayment calculator in a new window and create a couple of different debt repayment scenarios.

The debt repayment plan shows you how long it will take and when each debt is paid off in full.

As discussed previously, what order you pay off your debts in is actually quite important, but perhaps not for the reasons you imagine.

Snowballs and Avalanches

You’ll see these terms thrown around quite a lot in the financial advice that you can find online. There’s nothing special or mysterious about them.

A debt snowball is the idea that, once you’ve paid off a debt in its entirety, you no longer have to pay the minimum payment towards it, and the amount you have to start paying down the next biggest debt is therefore that much bigger. Like a snowball picking up snow as it rolls downhill, you therefore gradually pick up speed and pay off your debts faster and faster. The idea here is that you pay off the smallest loan first, then roll that payment into the next smallest loan, and so on.

The debt avalanche method has nothing to do with avalanches and the metaphor doesn’t work like it does with “snowball”, but hey, people were use snow-related metaphors so they thought it sounded cute. This is just a shortcut way of saying that you pay the highest interesdt loan first. The advantage of this method is that you’ll pay less interest overall during your debt repayment journey.

Choosing to pay down the highest interest debt first (avalanche) is financially smart, but it’s worth checking how much you actually save. If it’s only a little over a very long period of time, it’s often psychologically better to pick the smallest debt first. The sense of progress and achievement that you get from ticking a debt off your list is, in many cases, more valuable than minor savings on interest costs. It can provide the motivation you need to make it to the end of your debt repayment plan.

Staying on Track

There are a million obstacles on the road to being debt-free, and you will often be tempted to flex or break your budget. You will always tell yourseslf it’s just a temporary thing, and it will always weaken your resolve going forward. Once you get into the habit of breaking the promises you make to yourself, future promises have much less weight.

The way to avoid this is to anticipate the things you will really, really want to spend money on, and to integrate them into your budget a long time before the decision comes up. This changes the decision entirely.

Instead of deciding whether you want to break your budget or stay on track, you’re deciding whether to buy that holiday, that gift, that restaurant meal that you planned for, or to redirect that pot of money towards your debt. You now have the opportunity to accelerate your debt repayment plan or enjoy the treat you’ve been saving for. Both decisions are positive, and you are no longer trading your debt repayment journey for a passing desire.

You should therefore integrate your future spending desires with your monthly budget and put money aside into an indulgences fund, if you think this is something that might happen to you.

There are a lot of other ways of staying on target, and a lot of motivational literature out there to help you keep your focus. My article on the topic is here: How to stick to a budget.

Continuous Improvement

You should always be striving to save more and spend less. Especially during this debt repayment period of your financial life. It’s important to get to the end of this journey, and the faster you do it, the less it will demand of you.

To this end, you should be reading everything you can find about cost reduction. Whether it be spending less on groceries or reducing your utility bills, living without a car or using a meal planner to reduce your food bills. As you integrate these tricks and hacks into your life, you may find the budget becomes easier to stick to. When your budget doesn’t feel like a constraints, that’s a sign you need to review your budget and tighten it. It’s an opportunity to spend even less and pay off your debts faster.