There are two kinds of debt: The sort where you skip good lunches, and the sort where you’re researching the market price of your less important internal organs. There’s a tipping point; and once you’re at the stage where you can barely pay the interest, you need more serious measures. We talk to financial adviser and author Sean Lim, about debt recovery:
Falling into Debt
When someone falls into debt, it’s like a comic book character falling in toxic waste: They’ll either die in there, or emerge with super powers.
Depending on your mindset, being in debt will either (1) triple your financial IQ, or (2) turn your life into a dark cesspit of misery, much like Ming Arcade next to Forum.
Most people fall into the latter category.
But not our consultant for this article, Mr. Sean Lim. He’s the director of Financial Alliance, which deals with various personal financial investments. If you’re reading this on Yahoo, it’s also the company commentors below are right now accusing me of promoting.
(For what it’s worth, no, this isn’t an advertorial).
Sean is also the author of Happiness Within Your Reach. It’s about finding the better parts of life. Sean’s been in financial difficulty before, and come out stronger for it. I asked him how.
The Psychology of Dealing With Debt
The best mindset for resolving debt? Break things into small, detailed steps. This includes goal setting.
Worrying about the entire sum is an express ticket to a padded cell. Most survivors mentally break the debt into small parts, and focus on one or two at a time. For example, rather than stress over owing $80,000, you’d break that sum into small portions:
- Credit cards
- Car payments
- Friendly loans, etc.
Then for goal setting, you’d focus on prioritizing and fixing them one at a time. As such, the numbers on your mind are smaller (e.g. $5,000 on credit card A, $3,000 on a loan from Aunt Bertha…). Resolving them one at a time gives you a sense of progress, which stops you giving up.
Besides that, you also need to go micro with book-keeping. Sean mentions that:
“You must develop a budget. When I was poorer I recorded all my expenses: How much I ate for lunch, how much I spent for transport, and so forth. You can spot the top five costs, and you’ll know what to cut down on. I kept the habit, even today I keep track of expenses.”
You also need to…
1. Prioritize Loan Payments
Sean suggests you note down the various loans you have, and pay them in order of interest, highest to lowest.
“Pay off the loans with the highest interest first. These are usually credit cards; the interest is around 24% per annum.
After that, you should pay pawn shop loans, which are around 18%. Then any GE Money*, which is about 12% interest, and then your friendly loans. Friendly loans are from friends or relatives; sometimes they don’t even demand interest.”
(*GE Money = Refers to a division of General Electric Capital, a major issuer of personal loans).
It’s about going micro, and paying attention to various interest rates then?
“Yes, you should compare the loan interests. And sometimes you’ll see it’s worth transferring the loan,” Sean says, “For example, you can make a balance transfer, and pay off a higher interest loan with money from a lower interest loan. Do some research on the banks and other credit sources.”
But what about the idea of closing off smaller loans first? Some people believe you should close small loans before moving on to big ones, regardless of their interest.
“It can feel more reassuring, because you can see the progress. But it makes sense to pay the higher interest loans first. Because of high compounding interest, you will end up requiring more money to resolve your debt.”
2. Don’t Just Budget, Try to Earn More
Quick, list the things you can cut from your budget.
Once you’ve canned the phone line, cappuccinos, nice shoes, etc. what are you left with? Food, water, housing, medicine. There’s nothing left that you can cut. Budgeting has an upper limit.
Earning capacity, on the other hand, hasn’t got one. Yeah, I’m being an optimist, but you know what I mean: There’s a definite limit on how much you can budget, but indefinite limits on how much you can earn. And if you’re in debt, you owe it to yourself to explore that.
“There are side jobs that you can do while working,” Sean says, “Depending on your strengths, you can do some freelance work. There are usually companies that needs admin work done. Or you can be a referrer; for example some companies will give you a small referral fee, once the client pays or opens an account.”
And this is the super-power that being in debt can bestow. Once you develop an eye for opportunity, it tends to stay with you.
3. Continue to Save and Invest As You Can
There’s no point blowing 90% of your income on loan repayment. Not if you’ll run out of money before the next pay day, and end up using credit again. That just perpetuates a debt cycle.
Likewise, don’t ignore savings. If you channel all your cash into repayment, then can’t afford a doctor when you get sick…well, you better hope your lunch of moldy bread is full of penicillin. Missed work eventually means less pay.
Continue to set aside 5% – 10% every month, depending on what you can afford. If it slows the debt repayment a bit, so be it. When emergencies happen, the accumulated savings might be enough to cover them. That means not having to borrow on interest.
But what about investments? Sean suggests:
“You must know the interest rate of your loans. Once you have paid off your higher interest loans, you can try to find investments with growth that beats your loan interest rates.”
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