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Alvin Hall's blog
Alvin Hall's blog
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Ask Alvin: cash management

Reader's question;

Dear Alvin,
I have a loan and a credit card – which should I prioritise in paying off? I am struggling to manage my debts and make ends meet each month. I can just about pay off my credit card and debt re-payments, but am left with very little to do anything else and it's really getting me down. Any ideas?
Paul

Alvin's Answer;

Before you do anything else, stop using your credit card until you’re in better control! I suspect that when you’re feeling down and are out with friends, you say to yourself, “Oh, to hell with it!” and charge something you know you shouldn’t. Later, you are regretful, especially when the surprisingly higher bill comes due. You—and nobody else but you—will trap yourself in this frustrating and depressing cycle if you keep repeating this behavior.

Here are two proven strategies to help you pay off your debts—and have a little fun, too.

Write down a complete and accurate listing of your monthly after-tax income and then your monthly expenses. Try to list each expense in the priority it must be paid. Rent or mortgage, for example, would be at the top of the list,; while discretionary spending (such as takeaways, nights out with friends) would be at the bottom. Once you have deducted all of your expenses from your income, you will have a realistic view of how much money you have—or don’t have—available to pay toward your credit card and loan. The number shows you clearly why you’re feeling pinched each month, and down about it.

Like many people, you are probably not spending in ways that are well-prioritized. Look carefully at your list of expenses and see which ones are unnecessary. Cut them immediately. One of the expenses you should add to, not cut from your list is a fixed amount of cash (yes, cash, not a charge on your credit card) you permit yourself to take out of your income every week or two to do something that will be fun, that will lift your spirits. Make the amount what you know you can afford realistically, not what you imagine or fantasize you can afford. By using cash, you avoid adding to your debt and you know you’re within your spending limit.

To prioritize your debt repayments, you need to check the annual percentage interest rates (APR) you are paying on the loan and credit card. The one with the highest rate is the one you should always pay off first. Why? It’s costing you the most in terms of real money—i.e., the interest that accrues to the outstanding balance every month. I would hazard a guess that the credit card has the higher interest. (Typically consumer debt, such as credit cards and store cards, has the higher APRs.) Using the money you have determined (after deducting all of your expenses) you have available for debt repayment, make only the minimum required payment on the lower interest rate debt, while allocating the majority of this money to paying off the higher rate debt. You’ll be paying down your most costly debt first. You may have to cut some of your discretionary spending to make this possible.

Another approach that works is to allocate the after-tax money you earn one day each week (on Wednesday, for example) to paying off your credit card and loan using the strategy described above, and then to live off the remainder—in a well-prioritized way. Given a five-day work week, you are in effect allocating 1/5 or 20% of your after-tax income to debt repayment, and living on the remaining 80%.

Beyond having a complete and accurate numerical understanding of your income and expenses, the real key to making either of these proven strategies work can be summarized in three phrases: setting priorities; being self-disciplined; and motivating yourself. Paul, these phrases are your new mantra.
 

Thursday, 29th September 2011

Tags:   alvin hall  /  cash  /  credit card  /  debit card  /  money  /  debt
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