Several people who recently joined my mailing list emailed me to say that dealing with debt is their number one issue. If you’re in the same boat, this post if for you.
I thought I’d share a hack that I taught to some of my coaching clients for dealing with sticky debt – you know, the type that seems to cling to you no matter what you do. It hangs around for years and never gets the hint that it’s time to go away.
Here’s a suggestion on how to boot it to the curb once and for all.
Clarify the problem
In my experience, debt is usually not a money problem. Strictly speaking, since there is more money going out than coming in, it is a money problem. But that’s the symptom.
The root cause, for the people I worked with, had little to do with money. It had to do with mindset and habits.
People who find themselves in debt either enjoy spending more than they enjoy saving, or they spend unconsciously, out of habit. They keep spending even though they know they have debt and they say they don’t want more debt. And there is the crux of the problem: habitual overspending.
Huge caveat here: If the pandemic has pulled the financial rug out from under you and you find yourself accumulating debt as a result, these comments do not apply. No one could have foreseen Covid-19 and its impact. Be kind to yourself and do what you can, when you can. Pop back in when you’re ready and use the hack below to deal with the debt. But really, first, do what you can today.
Also, if you are in debt because of structural issues – inequality, lack of access to education growing up, dealing with poverty due to life circumstances, etc – then ignore my comments about the root cause. Structural, societal issues that leave people in debt pose a completely different challenge. I’m not for a second suggesting that changing your habits would address your debt problems.
For those for whom debt is preventable and reversible, let’s pop back to my earlier point: Before you can solve a problem, you have to understand it. Otherwise, you’ll pay off a whack of debt and dive right back in soon afterwards. That’s how sticky debt forms. It becomes habitual.
If you’re going to kick debt to the curb, you have to do two key things before putting together a strategy for repayment:
- Decide that you’re breaking up with debt, particularly corrosive debt. The latter is a term I coined to describe the impact of high-cost debt. I call it the hydrochloric acid in your finances. Nasty. Very simply, corrosive debt is debt that costs you more than you would make if you invested the same money. Every credit card on the planet produces corrosive debt if you run a balance. The same goes for most lines of credit.
- Make your spending visible. One of the reasons that spending adds up so quickly is because it’s painless to do in our era of plastic or tap ‘n go payments.
The psychology of spending
Behavioral economists like Dan Ariely and Richard Thaler have demonstrated that the less pain there is when we buy something, the more we spend and the less aware we are of our spending. Consider this from Ariely in his book Dollars and Sense (co-written with Jeff Kreisler):
Studies have found not only that people are more willing to pay when they use credit cards, but also that they make larger purchases, leave larger tips, are more likely to underestimate or forgot how much they spent, and make spending decisions more quickly.
[Credit cards] seduce us into thinking about the positive aspects of a purchase, in contrast to cash, which makes us also consider the downsides of the purchase and the downside of parting with our cash.
Hacking the habit
One of the ways I came up with to help clients break the habit of overspending is to make their spending visible. Some financial coaches advocate for the use of cash for all purchases, but that’s not possible in all instances, nor is it practical in a world that is moving away from cash.
We need to learn to handle and manage automated forms of payment.
Back to my hack.
The advantage of paying for purchases using a debit card is that you see your bank balance diminish every time you use it. The feedback loop is instantaneous.
It also has the advantage that you cannot go into debt with a debit card. If you don’t have the money in your account, you can’t make the purchase.
I wanted to mimic some of that feedback loop with the use of credit cards, so I created a system that requires two chequing accounts:
- Account A, your main chequing account – Your income flows into this account
- Account B, your purchases chequing account – Contains only money for the purchases you’ve made using your credit cards
You don’t pay a penny in fees for the chequing accounts, because you use free accounts such as are available from Simplii Financial and Tangerine in Canada.
Go about your daily routine, ensuring that you get receipts for every purchase made on your credit cards.
At the end of the day, you compile your credit card receipts, calculate the total amount of money you spent on the cards during the day, and you transfer that amount from your Main Chequing Account to your Purchases Account.
You then create automated payments for all credit cards using Account B. You never touch the money in Account B. The money simply gets transferred in from Account A and goes out when the credit card companies automatically withdraw their payments, using the pre-authorized debt payment you’ve set up.
Two big advantages
There are two big wins to setting up this kind of system.
First, you’re adding some pain back into the transactions by making your spending visible on a daily basis. This will increase your awareness of how much you spend and cause you to rethink purchases when you know the money has to come out of your main bank account at the end of the day.
Second, your debt balances will decrease simply because you are no longer adding to the debt load. Your spending will necessarily be limited to the items you can afford to pay for in full over and above your debt repayment obligations – you still need to make payments on your cards on top of paying for the stuff you’ve just purchased.
Turbo charge debt repayment
Now that you’ve got your spending under control – no additional credit card or line of credit debt – you can crank up debt repayment by doing the following:
- Focus on increasing the amount you pay off on a monthly basis. Increase your payments by a fixed amount on a regular schedule. For example, you might set up payments that are $100 more than the minimum balance. Every quarter, you increase the amount you pay off by $50. Let’s say you’re making $200/month payments on your Visa card. You would increase the automated payment to $300. Three months later, you would increase it again to $350, and so on. Pick amounts that are doable for you. The key point here is to incrementally increase your automated payments. Think of the upside: Every dollar in credit card debt you pay off gives you an approximate return on your money of 18% – 30%!
- Throw 95% of extra money – tax return dollars, side hustle money, raises, bonuses, etc – at the debt. This will compound your returns and get you to your Debt Free Destination much sooner.
- Make debt repayment your primary focus and mission. If you’re married, get your spouse on board. This is a team project, unless your finances are completely separate.
- Focus on eradicating one particular debt first. Put a bulls-eye on it and keep the diminishing balance front and center. Use the Snowball Method (tackle the smallest balance first) or the Avalanche Method (tackle the highest cost debt first – my personal favorite because it gets rid of debt faster). Pick the approach the works for you. The goal is to keep yourself in the debt elimination game.
- Plan a mini (no cost) celebration after every milestone.
Some personal finance writers are quite dogmatic about the approach you should take to debt repayment. Dave Ramsey, for example, insists you use the Snowball Method because it’s the only method that makes psychological sense. He correctly notes that personal finance is 80% behavioral (I don’t know about the percentage, but it is mostly a game of mindset and behavior in my experience with clients over the past 15 years.)
He clearly hasn’t met me, though, because I’m of the opinion for my own money that debt is debt, and I would want to get rid of it asap, which means knocking off the most expensive debt first. That’s the approach I used to pay off $400,000 in two years. I did not give up, nor would I have felt better if I had tackled the smallest debt first. My main motivators were the amount I owed in principal and how much I was paying in interest every month. That’s it.
I’m not a fan of dogma in personal finance because it misses the obvious – your money is personal. Do whatever works for you.
If you have a strategy that worked well for you, please share below.
Good luck knocking off your debt. I can tell you the payoff is worth it – peace of mind and greater financial freedom! Reach out if you need help.
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