Hello best life seekers!
If you read the first 3 Rules of the Beginning Wealth Series, you know that living on 70% of net income and investing the remaining 30% in money-making activities is the heart and soul of financial independence and freedom.
However, if you are up to your eyeballs in debt, implementing the 70/30 principle might be difficult or nearly impossible for you. A good indicator that you are swimming in debt is when your total debt payments exceed 35% of your net income. This is the threshold many banks use to assess a person’s ability to pay back loans. Bankers know that past this percent of income, people may struggle financially, with any little emergency threatening their ability to pay their debts and expenses.
What is your total debt payment to net income ratio?
Debt Free Isn’t Always Preferred
A lot of gurus will recommend focusing on becoming debt free but this isn’t always a wise use of your money. Say, for example, you are an average American with $90,000-$130,000 of debt. However, your debt payments run less than 35% of your net income. Rather than paying off your debt, you might still consider using the Rule 3 money in the traditional 10/10/10 ratio of 10% net income to passive income, 10% to portfolio income and 10% to business investments.
Let me give you an example to illustrate.
Suppose you owe $100,000 at a low interest of 3%. If you paid off the amount you owe, you won’t have that $100,000 to invest in a business or toward an asset like a rental property or private-lending interest income. Maybe you want to start your own wedding photography business and that extra 10% would go toward purchasing equipment and leaving the rat race sooner rather than later. If you can make money on these other investment ventures or greatly move toward your envisioned lifestyle, your money would likely be better utilized by investing in those routes than by paying off your debt, a debt you are already managing fine. You would have more freedom and options as it were.
If, however, your debt payments are moderate or impossible to manage under the living on 70% rule or just overly stress you out, you might consider modifying the 30% Rule. Use 10% on debt down-payment and allocate the remaining 20% to passive income, portfolio and business investments however you see fit. Or maybe you can pay it all off in 2 years by using the total 30% and that sounds like a good sacrifice to you. Even so, you want to place the debt payments under the 70% Rule as quickly as possible and not be digging into your money-generating 30%. Remember, don’t shoot your gold-laying goose!
When Debt Elimination Makes Sense
However, if you have $100,000 at high interest that you can’t transfer/consolidate lower and your debt payments are more than 35% of your net income, then you probably want to focus on paying down that debt to manageable levels. Too much debt puts you in the cross-hairs of financial jeopardy if an emergency stresses your resources before you have built them up. That and as we noted, lenders will begin to consider you a gamble better not taken.
In this case, you might put most or all of your 30% into paying down debt until it reaches the 35% of net income threshold, then reassessing at that point. Again, ideally you want all your debt to be met by the rule of living on 70% of net income and investing the remaining 30%.
How to Bomb Away Your Debt
There are a number of wise ways of eliminating debt and alleviating the strain of payments. Usually we carry various forms of debt, like credit card and student loan debt or medical debt or mortgage debt. Pick your poisons. Some of these balances can be huge while others small.
In general it is unwise to spread your extra payments across accounts. You want to target one debt for maximum efficiency. Debt elimination strategies worth considering:
- Pay off the balances with the highest interest first to get the most bang for your buck.
- Pay off the smallest debt first to give yourself a sense of accomplishment and motivate yourself to keep tackling the others.
- Pay off the smallest debt with the highest monthly payment so that if nothing else, you are lowering your monthly debt payment ratio the quickest.
- Use the snowball method to pay off one debt, then tack that amount onto future extra payments on the next debt.
- Transfer debt to a lower interest balance plan. If you qualify, Discover card and others offer decent low rates on balance transfers or by using their checks to pay off debt elsewhere.
- Consolidation may or may not be worth it so consider it carefully as an option.
Debt Payoff Wrap Up
How and when you pay off your debt is a matter of personal preference but ultimately it boils down to finding a method that actually works for you and motivates you to continue toward your lifestyle goals. Maybe you decide that 10% toward debt would be perfect or that you’ll sacrifice the entire Rule 3 goose until you’re at the 35% of net income for your debt payments. It can take a while to completely squeeze into the 70/30 metric so play with the numbers to get yourself there. Whatever you implement, you’ll have a stronger financial foundation for your best life.
Next, examine how to bulletproof yourself from emergencies in Rule 4: Stash Your Cash.
- Beginning Wealth Series Introduction
- Rule 1: Know Your Wealth
- Rule 2: The Midas Lifestyle
- Rule 3: Make Money Work for You
- Rule 3: Debt Payoff Option
- Rule 4: Stash Your Cash
- Rule 5: Don’t Dig Money Pits
- Rule 6: Body of the Gods
- Rule 7: Hustle
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