How To Become Debt Free

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It's important that we become debt free first before we even start investing and building for our retirement (if you have the money to do both go right ahead). This is because interest rates in debt are usually higher than the interest rates earned from investments. So any money you earned from your investments will just be eaten up by the interest of your debt and you'd be money in the process (not all debts are bad though, there is what we call good debt as well; click here to know more).

For example lets say you put P10,000 in an investment vehicle that is earning you 10% annually. So you're money would be earning P1,000 pesos in its first year. Now let's say you have a personal loan of P10,000 payable in 12 months with an effective rate/annum of 17.07% (This is the rate for an Asenso Kabayan Program - Secured in BDO), so you're debt will grow by P1,707. Now your investment earns P1,000 but your debt grows by P1,707 so you're still down by P707 Instead of making money, you're losing money because of your debt. So its important that we become debt free first before we start investing (especially those who don't have money to do both) so our money can truly grow without worrying about interest rates on debt eating it up.

But how do we become debt free? Is there an easy way to eliminate our debt without using up your entire income to pay it off?

There is actually a way to do it. Its a method that I learned from reading Robert Kiyosaki's Rich Dad's Guide To Becoming Rich Without Cutting Up Your Credit Cards.

His method involves you finding additional money from your budget (this can be easily done by cutting some of your expenses and spending wisely, check this article for more ideas). Then cut off your other credit cards (not all, but some to refrain you from using it and add to your debt already).

Using the methods that I learned, I added some modifications in that its important to pay off you're smallest debt first regardless of interest rate.

More often people tend to pay off a little extra to each debt in hopes of paying it off sooner. The problem though is that it usually doesn't happen that way, the debt just doesn't seem to lessen. Robert Kiyosaki suggested to add the extra money you can find in your budget to pay off one debt and pay the minimum in the others. My suggestion though is to pay off the debt with the smallest amount first while paying minimum in the others.

In short you should eliminate first the debt that is easier to eliminate so you'll actually lessen the debt that you have. Once you've paid off the easiest debt to pay, add the amount that you pay to that debt to pay off the next debt that is easiest to pay off.

For example:

Debt A is worth P1,500

Debt B is worth P5,000 

Debt C is worth P10,000 

The minimum amount for each debt is 10% of the debt amount (P150 for debt A, P500 for debt B and P1,000 for debt C). 

Your budget for paying off your debt is P2,000 so this is how you divide it:

P500 for Debt A

P500 for Debt B

P1,000 for Debt C

Let's say you have an additional P300 out of your budget due to some financial management, so add that to pay off Debt A.

So with P800 a month budget, you'll be paying off debt A in just 2 months. After that use that P800 and add it to pay off debt B, increasing your budget for debt B to P1,300. You'll be paying off debt B quickly that way (even if the debt increased in amount because of only paying the minimum, the added amount to pay for your debt will more than cover the increase due to the interest rate). Follow this method as well to pay off debt C and you'll see yourself eliminate your debt.

This method might not eliminate your debt quickly, but it will surely eliminate it at a rate faster than if you just keep on paying all of your debt just above the minimum in hopes of eliminating them faster.

Becoming debt free is important if we want to fully see and feel the earnings that our investments are making. You can also use the added money to fund your other ventures. So rid yourself of bad debt and take full advantage of the interest rates that our investments are earning.