RPF-0032-What_Order_Should_I_Pay_Off_My_Debts-Lower_Sample_Rate
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00:00:30.240 | Radical Personal Finance, Episode 32. What order should I use to pay off my debt? A rational
00:00:40.240 | approach to the debt snowball, the debt avalanche, the debt tsunami, and all of the other debt
00:00:46.000 | and precipitation terms you can throw in.
00:00:48.000 | Welcome to the Radical Personal Finance podcast for today, Thursday, July 31, 2014. Today
00:01:12.160 | we're going to try to stir up the hornet's nest a little bit, try to give a little bit
00:01:16.240 | of information and some, what I think, rational ways of thinking and considering the details
00:01:22.480 | of how should I go about paying off my debt. I've decided to pay off my debt, but what
00:01:28.120 | order should I use to pay off those debts? This is one of the biggest, I don't know,
00:01:40.680 | if you pay attention to the personal finance world, you'll know this is an ongoing debate
00:01:44.560 | that everyone likes to argue about. If you don't pay attention to the personal finance
00:01:47.560 | world, this may be news to you that this is even a controversy of any sort. I often talk
00:01:53.920 | with people and I mention this controversy and they look at me with a blank stare like,
00:01:58.880 | "Why would anybody do that?" That being the other thing that someone else would say, "Why
00:02:04.040 | would anybody do this one?" It's rather comical to me just because everyone has this broad
00:02:10.080 | range of opinions. This is one of those things where sorting out right and wrong is challenging
00:02:20.320 | because it's personal. I think this is an excellent example to use to show how I think
00:02:30.240 | that we who are interested in finance, we who are interested in a rational approach,
00:02:35.840 | a rational and radical approach to finance, to personal finance, I think we have a responsibility
00:02:41.640 | to up our game in this area because there are literally millions of people that are
00:02:47.640 | depending upon us, those of us who are interested in this stuff, whether we're a financial advisor,
00:02:52.480 | a financial blogger, just an average person who's interested in finance, all of us are
00:02:58.640 | going to have the ability to impact someone else's life when they ask us questions. I
00:03:03.040 | think we have a responsibility to help them and there are millions of people who need
00:03:07.200 | our help. It doesn't help to do this infighting, these arguments back and forth about debt
00:03:13.840 | snowball versus debt avalanche. If you're not familiar with those terms, give me a moment
00:03:17.040 | and I'll explain them to you. Today, I'd like to just give some thoughts and some ideas
00:03:23.080 | for how we could go a little bit deeper than just this back and forth argument. I believe
00:03:28.720 | this will be helpful. I wouldn't be doing it if I didn't believe it would be helpful.
00:03:32.160 | But I believe there's another layer that we really need to talk about and we really need
00:03:36.680 | to understand all of the forces at work in this entire conversation. We need to go beyond
00:03:43.000 | should I pay off my debt in the highest balance first or should I pay off my debt in the highest
00:03:47.800 | interest rate first. If we can go beyond this argument, we can stop fighting among each
00:03:54.200 | other and start helping more people. Those of us who care about these topics, we're not
00:03:59.280 | the enemy. The debt is the enemy. The consumer debt is the enemy. So let's focus on that
00:04:04.640 | and let's clear the way for that.
00:04:07.520 | So first I want to lay out the problem and just some of my assumptions for today's show.
00:04:11.480 | In today's show, I'm not going to talk much about getting out of debt. But to be clear,
00:04:15.560 | I think getting out of debt is an incredibly important step on the path to financial independence
00:04:21.640 | and financial freedom. If I could help any young person avoid going into debt from the
00:04:27.320 | beginning, I would. If I could help any person get out of debt, I would. I don't want to
00:04:32.880 | provide any comments today on the topic of getting out of debt versus investing, although
00:04:38.240 | I have some pretty strong feelings on that as well. It's not as simple as one or the
00:04:42.160 | other. It's a very individualized decision.
00:04:45.400 | But today I'm just going to assume we've decided we want to get out of debt and we've decided
00:04:49.440 | that this is our number one focus and this is our number one priority. There may be many
00:04:54.100 | reasons why this would be the ideal thing to approach and the ideal thing to do.
00:05:00.840 | So let's talk about some different ways to do that. This may sound silly, but there are
00:05:05.200 | various debt reduction methodologies that you could use. I've thought of five of them
00:05:11.720 | to use in our conversation today.
00:05:14.640 | The first one is what I call the minimum payment methodology. The idea behind a minimum payment
00:05:19.360 | methodology is you just simply pay your debts according to how much your creditors are charging
00:05:24.560 | you. So you take your statement every month and you take a look at it and whatever the
00:05:28.440 | payment, the minimum payment is that it says there on the statement, you pay that amount
00:05:31.800 | off. Now this can work brilliantly for some kinds of debts and this can be a disaster
00:05:36.480 | for other kinds of debts. So this can work brilliantly for what are called fully amortizing
00:05:42.120 | debts with level payments. So this may work well for a mortgage payment. We all know that
00:05:47.680 | if we have a mortgage payment and we have a traditional fixed rate mortgage payment
00:05:52.000 | with a level payment, we know that over time if we just pay that level payment that upon
00:05:56.680 | the term of the loan maturing, that that payment will be paid off. So if we took out a 30-year
00:06:02.180 | loan and we pay that level payment each month for 30 years, at the end of 360 months that
00:06:08.160 | payment will be paid off. Or if we have a car payment, then this car payment will be
00:06:13.560 | paid off under the terms of its loan. So if it's a 60-month loan, we know that 60 months
00:06:17.640 | later this car will be paid off and we'll have a level payment over that 60-month period.
00:06:23.120 | The minimum payment methodology is a little bit more tricky when you get into the world
00:06:26.840 | of student loans and also when you get into the world of credit cards. The challenge is
00:06:31.320 | especially with credit cards of this payment methodology because as you pay the loan balance
00:06:37.360 | down, the minimum payment changes. And so with most credit cards, the way that the minimum
00:06:41.760 | payment is calculated is that if you start off with a $10,000 balance and that balance
00:06:47.320 | declines, then the minimum payment will be recalculated. So under a credit card minimum
00:06:53.280 | payment methodology, you'll wind up paying a substantial amount of interest if you just
00:06:57.880 | pay the minimum payments. Student loans vary depending on the nature of the loan and there
00:07:02.280 | are some funky things with student loans that I don't want to get into today as far as the
00:07:08.160 | various repayment options and various forgiveness options and things like that, various terms
00:07:12.960 | where the payments are not due and then the payment calculation being based upon income.
00:07:17.480 | So a little bit funky. Just look and read the terms of your loan for that. So the minimum
00:07:21.520 | payment methodology is frankly what many debtors wind up doing. That's what many debtors wind
00:07:28.680 | up doing because if you're a debtor and you just pay the minimum amount that you need
00:07:33.200 | to do and those minimum amounts can accrue and accumulate over time. And the challenge
00:07:37.760 | is that's usually going to be the slowest way to pay it off. Now many people who are
00:07:41.280 | in debt do want to pay off their debt more quickly and get things cleared a little bit
00:07:45.600 | faster. And so then that brings us to debt reduction methodology number two, which I
00:07:50.080 | call a little extra here and there. And so this would be I pay a little extra here, I
00:07:54.640 | pay a little extra there. I'm putting a little $50 extra on this credit card. I'm putting
00:07:59.000 | $50 extra on that student loan and I'm just kind of paying a little bit more as I have
00:08:03.400 | the opportunity to pay a little bit more. This is frankly quite normal. This is what
00:08:07.680 | many people do. And this is why those who have ongoing balances of their debt payments,
00:08:15.080 | ongoing balances on their debts, they often don't feel like they make much progress because
00:08:20.200 | the energy is spread out. And so I agree 100% with the various personal finance gurus and
00:08:25.560 | pundits that comment on this topic. It makes all the sense in the world to me. This is
00:08:30.080 | probably the least effective way of paying off debt because $50 here, $200 there, $1,000
00:08:36.280 | on the other debt makes you feel like you're never making measurable progress because you
00:08:40.440 | don't have a plan. And so this is probably the least effective. And I would encourage
00:08:46.080 | nobody to follow this one. I would encourage anybody to pick one of the other methodologies.
00:08:52.240 | So then we move on to kind of the other methodologies that are more proclaimed. I'm familiar with
00:08:59.000 | three or four depending on how you count them. There's two biggies and then there's one or
00:09:03.400 | maybe the same thing, two that I've heard of here and there in paying attention to personal
00:09:08.400 | finance stuff over the years. The two biggies are what are called the debt snowball and
00:09:12.280 | the debt avalanche. And then the other two is the debt tsunami and the risk reduction
00:09:16.840 | method. Those are just some various names that I have heard for paying off debts. And
00:09:22.200 | I'll explain them one by one. So the biggie in the personal finance space is the idea
00:09:26.160 | of the debt snowball. All four of these, by the way, are trying to harness the same focus
00:09:32.880 | methodology. And so the idea here is that with any one of these payment methodologies,
00:09:39.600 | the idea is that you will pay a minimum payment on all of your debts except one. And you will
00:09:45.320 | pick one balance, one debt to which you're going to focus all of your extra payments
00:09:50.680 | over and above and beyond the minimum payment that's required. And then by focusing on that
00:09:57.240 | payment, on that debt, you will clear that debt and then you'll take the amount of money
00:10:01.840 | that you were paying towards that debt and then you'll roll it towards the second debt
00:10:06.760 | on your list, whichever that second debt happens to be. And then you'll move on to the third
00:10:11.480 | debt, then on to the fourth debt, then on to the fifth debt. Now this is extremely powerful
00:10:16.040 | as a debt payment methodology because instead of just simply paying the minimum payments
00:10:21.600 | and then when one debt is cleared, you continue paying minimum payments on the others, by
00:10:25.440 | focusing the efforts on one and then rolling the payment that was being paid towards that
00:10:30.280 | one once the first one is paid off to the second one, then the amount that you're paying
00:10:34.120 | each month towards the debt grows substantially over time. And so this is really powerful
00:10:40.600 | because it focuses your efforts. And then by focusing the efforts onto one specific
00:10:44.800 | debt, by focusing on one specific debt, then it concentrates you and gives you the power
00:10:50.840 | of, basically the power of focus. I think there was a book written with that name. It's
00:10:54.000 | the power of focus. Basically anything we focus on, we're able to make substantial progress
00:10:58.040 | on and it's no different in the area of debt repayment. So I want to walk through these
00:11:03.560 | different methods. So the most popular of these four is called the debt snowball. And
00:11:09.480 | the reason it's the most popular is because this is the method championed by the big,
00:11:14.480 | the big dog in the personal finance space, Dave Ramsey. And so Dave Ramsey champions
00:11:18.880 | a method that he calls the debt snowball. And I assume he didn't make up the name. I
00:11:22.920 | assume he just popularized it. But if he did, I give him all the credit. I don't know where
00:11:26.760 | these names came from. And the idea behind the debt snowball is to pay minimum payments
00:11:34.840 | on all of the debts except the one with the smallest balance. So if you have a -- you
00:11:41.040 | have three loans and one of them has a $1,000 balance, one of them has a $10,000 balance,
00:11:45.520 | and one of them has a $5,000 balance, you ignore the interest rates and you focus on
00:11:50.360 | the one with the smallest balance. And the idea here is to harness the power of behavioral
00:11:56.320 | modification and set yourself up for a feeling of success by getting a win of paying off
00:12:02.680 | the debt quickly. So the analogy that Dave will use and that I think is accurate is anything
00:12:11.360 | that you start, for example, dieting, if you focus on what can I do in the first -- what
00:12:15.960 | can I do up front and what can I do -- if you go on a diet and you lose five or ten
00:12:20.760 | pounds really quickly, your more -- idea is that you're more motivated to stick with your
00:12:25.640 | diet. So the same thing. If you can -- if you have a list of five debts and you have
00:12:29.200 | two little ones and you can get that little -- the first little one cleared out in the
00:12:32.640 | first month and the second little one cleared out in the second and third month, then this
00:12:36.320 | is a really powerful motivating factor to help you stay on the plan. So now you've gone
00:12:42.240 | from five debts to three debts and you get some wins of not having to face those bills
00:12:48.040 | and those debt statements in the month -- in the mail every month. The critics of this
00:12:52.960 | methodology will quickly complain, well, what about the interest rates? And, you know, if
00:12:58.480 | you're paying off the debt that has the smallest balance, it may also have the lowest interest
00:13:02.840 | rate, so therefore the interest rate -- the higher interest rates on the other debts are
00:13:06.480 | continuing to accrue and you're paying more money. And I'll go into this in detail because
00:13:10.280 | that's the point of today's show. We're going to do some number crunching and show when
00:13:13.760 | this matters and when this doesn't matter. So that's what the critics would say is that
00:13:18.320 | you're paying more money in interest and then the defense for this method would be, well,
00:13:21.680 | yes, you're paying more money in interest, but you're harnessing the power of behavior
00:13:25.200 | modification. So that's the debt snowball. The next method of paying off debt would be
00:13:30.280 | what I would call -- or what is commonly called the debt avalanche. And so the debt avalanche
00:13:35.360 | is to list all your debts in order of the highest interest rate to the lowest interest
00:13:39.840 | rate and put all of your focus onto the payment that has the highest interest rate. By doing
00:13:47.600 | this, you're wiping out the interest payments and this will ultimately be the least expensive
00:13:52.600 | way to pay off the debts. Now, the critics of this method will say, well, yeah, it would
00:13:56.400 | be the least expensive way if you're able to stay motivated. But if you're not able
00:14:00.120 | to stay motivated, then you're not going to pay off your debt. You're not going to pay
00:14:04.600 | off your debt. So you're just going to sit there and be trucking away at this. Maybe
00:14:08.160 | you have a big debt with a high interest rate and you're just going to be sitting here trucking
00:14:11.960 | away at the amounts and you're not going to make any progress on it. But the defendants
00:14:17.960 | of this methodology would say, well, it's still going to be the cheapest, so it's going
00:14:23.840 | to be the fastest and you're going to pay the least money out of pocket. Now, the other
00:14:27.640 | two are not -- so those are the two big ones, the debt snowball and the debt avalanche.
00:14:32.280 | And the other two are ones that I've just heard here and there. The debt tsunami, I've
00:14:36.680 | only ever heard this written by -- I heard this term, I think it was coined by Adam Baker,
00:14:42.520 | who wrote a blog called "Man vs. Debt." And his idea here with his debt tsunami was to
00:14:48.720 | focus on the most hated debt. And his idea was, why don't you harness the power of behavior
00:14:53.960 | modification by focusing on the debt that you hate the most? So, for example, if you
00:14:58.640 | have -- if you owe a credit card balance that is for an ex-spouse's spending prior to a
00:15:06.840 | divorce, and if you hate that balance, get rid of that first. Or if you owe a credit
00:15:10.440 | card balance and you just hate Bank of America for some reason, well, pay off that Bank of
00:15:14.640 | America card first. And so, his idea was harness the power of behavior modification by focusing
00:15:19.920 | on the most hated debt. And then, the other is similar, and this is the least popular
00:15:25.040 | that I've heard, but I've seen it in a couple of articles, basically the risk reduction
00:15:28.760 | method, which is the idea is you pick the riskiest debt to you. And so, this is similar
00:15:32.760 | to the most hated debt. And so, the idea is, well, figure out what your riskiest debt is.
00:15:42.960 | If it's a debt to your parents or a debt to -- on a mortgage that you want to make sure
00:15:47.760 | your house is paid off so you don't lose the house if you face difficult times, things
00:15:53.000 | like that. So, these are the different methodologies. And I'm going to -- we're going to do some
00:15:58.680 | math today, and I think I've got it simplified enough to be able to do it on a podcast. We're
00:16:02.640 | going to do some math, because here's my issue with all of these things, and I'm going to
00:16:07.520 | scream it loud and clear. This must be an individual discussion, because there are two
00:16:13.320 | things that are important. Number one is it's important to look at the individual's makeup
00:16:18.040 | of their individual debt. And number two, there's a whole realm that we're not talking
00:16:23.000 | about, which is the terms of the debt. And so, most of the time, people are always talking
00:16:27.680 | about what debt balance should I pay off and what interest rate balance should I pay off,
00:16:32.400 | but they forget about what are the terms of the debt. And the terms of the debt matter.
00:16:35.800 | And so, we're going to talk extensively about the terms towards the end of the show today,
00:16:41.040 | because I think we need to factor this in. Now, before we do, many people's -- I want
00:16:45.400 | to just give a disclaimer. Many people's debt situations are very simple. If you listen
00:16:50.600 | to Dave Ramsey's show, you listen to his radio show, the people that are calling in, this
00:16:55.840 | is the -- this is kind of the average American, low to middle income, struggling with debt,
00:17:02.240 | and the debt makeup is fairly simple. So, it's I've got a credit card, I've got a student
00:17:06.800 | loan, and I've got a car payment. And so, if you've got a credit card, a student loan,
00:17:10.440 | and a car payment, it may be fairly straightforward as far as which of those you should pay off.
00:17:14.480 | And so, I'm not mad about these methodologies, but the problem is that when we fight about
00:17:18.680 | them, we're missing the bigger picture, what's actually important. And so, we need to actually
00:17:25.440 | personalize this with people. We need to actually run a personal spreadsheet for each makeup
00:17:31.960 | of a debt -- makeup of somebody's balances. This is important. So, I'm going to pass along
00:17:37.720 | a tool in a moment, and it's the easiest tool I've found. It's totally free, and I'd encourage
00:17:42.720 | you to use it if you're trying to figure out what your -- what plan you should use for
00:17:47.760 | your debt, or if you're trying to help somebody else, whether that's a client, if you're a
00:17:51.840 | financial planner, or whether it's just a friend or a family member, if you're trying
00:17:55.360 | to help somebody else figure out what they should do as far as how they should focus
00:17:59.640 | on paying off their debts. The key thing in all of these plans is to understand basically
00:18:05.960 | what's the alternative use of the dollar. And so, the whole concept of paying off the
00:18:12.120 | -- of debts is that we're going to transition from consumption of money over to the paying
00:18:18.920 | off of debt, which is usually going to be consumer debt, which was previous consumption.
00:18:23.520 | And this is what many people who are deeply in debt or want to get out are going to do.
00:18:27.800 | And so, if you're -- if you are -- if you have a lot of debt, and you have a lot of
00:18:31.680 | consumer debt, and you're going to transition, and you're going to change dollars that you're
00:18:35.240 | currently spending, because you made your cash flow statement, and you're going to move
00:18:38.560 | some of the dollars that you're spending on consumption over to paying off your debts,
00:18:43.920 | then that's awesome. That's going to be a good move. But if the majority of your cash
00:18:48.600 | flow is going toward investment, and you're carrying debt for -- and you're carrying debt
00:18:53.680 | for investment purposes, then this is a very different conversation. And so, that's why
00:18:58.200 | in the future we will do some should I pay off debt or invest shows. But look at your
00:19:01.720 | cash flow statement. See where your money's going. Now, again, with the majority of people,
00:19:05.080 | at least in my experience, it seems fairly simple. We're going to allocate money over
00:19:09.000 | from consumption, from the consumption categories over to the debt repayment categories. And
00:19:14.160 | that's definitely going to be a good move. It's going to be very difficult for that not
00:19:18.280 | to be a good move. So, let's assume that's the case. Now, I've
00:19:22.840 | run some numbers, and I'm going to walk through those numbers to show you how this does matter.
00:19:27.320 | And for the sake of -- I don't -- it's hard to get too numbers intensive in a podcast,
00:19:32.000 | but I think I've been able to simplify it enough to make the point. And so, what I've
00:19:37.120 | done -- and you'll see why I've done this in a moment. But I've simplified, and I'm
00:19:41.600 | using a spreadsheet here that is a debt reduction calculator. And there will be a link in the
00:19:46.040 | show notes. This is the most useful spreadsheet that I have ever found that someone has created.
00:19:50.820 | It's for free. You can buy it. There will be a link in the show -- excuse me. It's for
00:19:54.200 | free. You can use it and download it from the link in the show notes. It is published
00:19:58.360 | on a website called Vertex 42, where they publish a lot of Excel templates and Excel
00:20:05.360 | -- basically Excel templates. And this is a calculator that someone has created that
00:20:10.160 | is a fabulous, fabulous calculator. And you can download it for free, and you can enter
00:20:16.000 | up to 10 debts, or you can pay for a version which you can enter more debts. It's 10 bucks
00:20:22.280 | if you need to list more than 10 creditors. So you can list up to -- you can have a list
00:20:26.840 | up to 20 creditors, or even as much to -- yeah, as much as 20 creditors. And this is fabulous,
00:20:33.840 | because instead of our sitting around arguing about what -- you know, what's right and what's
00:20:39.200 | wrong, we can calculate it. And we can calculate what our cost would be. So if we're going
00:20:43.400 | to do the method focusing on behavior modification, the debt snowball, we can calculate what the
00:20:49.640 | actual cost of the additional interest that we're paying would be. And I've done these
00:20:54.680 | calculations a lot of times with clients. I've done many of these calculations, and
00:20:58.600 | I've found that it's very important to do the individual calculation with a client,
00:21:04.500 | because the makeup of the debts and the terms of the debts matters. The interest rates matter
00:21:09.580 | and the amounts matter. So just to lay out a very extreme example to make my point, if
00:21:16.580 | you have three debts, one of them has a $20,000 balance, one of them has a $300 balance, and
00:21:23.000 | one of them has an $800 balance, and you're going to throw an extra $1,000 a month at
00:21:27.200 | your debt payments, I think it would be pretty smart to just go ahead and use the debt snowball
00:21:31.720 | regardless of the interest rates. Just ignore the interest rates, because, you know, in
00:21:36.240 | a month and a half, you've got your two little debts cleared. But if you have three
00:21:39.720 | debts of relatively similar balances, then it's a very different situation. So you
00:21:45.880 | can't just say one or the other. You've got to look at what's the actual makeup
00:21:49.100 | of your debt, and you need to look at the interest rates and the terms. So I've got
00:21:53.020 | a spreadsheet here, and let me tell you what the debts are that I've entered into it.
00:21:57.320 | And again, I'm using this -- I've simplified this to try to get this point across on audio.
00:22:03.180 | But I'm using three debts. I'm using credit card debt, a car loan, and student loans.
00:22:07.540 | So I've got credit cards, car loans, and student loans. And for the sake of illustration,
00:22:12.620 | I've chosen to make the one with the highest balance have the highest interest rate, and
00:22:17.140 | the one with the lowest balance have the lowest interest rate. And I've made these numbers
00:22:20.640 | up for the sake of illustration to show that -- first of all, these are reasonable numbers,
00:22:26.020 | but to show how this could really make a difference. And I would encourage you, follow the link
00:22:30.960 | in the show notes. Today's show notes are at RadicalPersonalFinance.com/32, and construct
00:22:36.380 | this for yourself. But let me use my example to show the difference. So I've got a $20,000
00:22:41.580 | credit card balance with an interest rate of 18% and a monthly payment of $500. I've
00:22:47.460 | got a $15,000 car loan with an interest rate of 8% and a monthly payment of $300. And I've
00:22:53.700 | got a student loan balance of $10,000 and an interest rate of 6% and a minimum monthly
00:22:58.620 | payment of $100. So my total minimum monthly payments are $900. And the way this spreadsheet
00:23:05.820 | works is because I have my minimum payment, it has to be paid of $900. But then I can
00:23:11.260 | choose to put in what is my extra payment. So what additional amount can I pay every
00:23:16.100 | month? Now, if I don't pay any additional amount, and I just pay these debts off on
00:23:22.100 | their -- and I just pay these debts off, but I pay a level $900, I'm still going to be
00:23:26.740 | out of debt faster. By the way, one disclaimer, I'm going to round some of these numbers to
00:23:31.780 | hopefully make them easier to hear on the podcast. So if there's a -- if it's $768,
00:23:37.060 | I'll just say $800. So I'm going to round a little bit to make the points. But you can
00:23:42.260 | again, you can calculate these out exactly to the dollar if you want to. So if you just
00:23:46.380 | pay the $900 payment every month, then you'll pay that for the first 62 months. And then
00:23:53.060 | after 62 months, the first two payments will be paid off. And then the full balance of
00:23:57.420 | the $900 will be moved over to the third payment. And it'll take a total of 69 months to pay
00:24:02.460 | off these debts under the terms that I have put them in here. So 69 months to take care
00:24:09.140 | of this. So that's just under six years to pay off the debt. Now, if you increase your
00:24:13.020 | monthly payment -- and so let's start with the monthly payment of $1,000 a month. If
00:24:16.940 | you put $1,000 a month in here, then it shortens things out. So let's start with an avalanche
00:24:21.580 | method. An avalanche of the highest interest rate -- let's start with the snowball method
00:24:25.420 | actually, which would be the lowest balance first. So if you're paying a snowball payment
00:24:30.140 | of $1,000 a month, so it's an extra $100 on top of the $900 of initial minimum monthly
00:24:36.420 | payments, the first debt would be paid off. That would be the student loan, starting with
00:24:40.420 | the $10,000 balance. That would be paid off in 58 months. And you would pay a total of
00:24:45.060 | $11,536 of interest. Then the car loan would be paid off at 60 months. So that would be
00:24:51.500 | -- you'd pay off the $15,000 balance and pay a total of $3,300 of interest. And then the
00:24:56.860 | credit cards would be paid off in 61 months. And you would pay off the balance of $20,000,
00:25:02.540 | and you would pay a total interest of $10,765. So the total interest paid would be $15,604.53.
00:25:12.580 | Now if you switch this and you say, "Okay, so I'm paying $15,600 of interest under the
00:25:18.500 | snowball method. What if I take exactly the same terms and I make it -- I'm going to continue
00:25:24.540 | to pay $1,000 a month, but I go ahead and put it at the highest interest rate first?"
00:25:30.220 | Well now I'm going to pay the credit cards first. And I'm going to have that paid off
00:25:35.060 | in 47 months, and then the car loan's in 52, then the student loan's in 59. My total interest
00:25:40.300 | paid would be $13,462. So you would pay a lower interest rate, $13,462. So if you subtract
00:25:51.180 | -- I'll just do $13,460 from $15,600, you can see that under the snowball method, you
00:25:59.660 | would pay an additional $2,000 of interest. So the snowball method is $2,000 of interest
00:26:06.940 | payments, more expensive. And then the amount of time that it would take to pay off these
00:26:11.900 | debts, if you looked at it, it would be a total of 59 months under the snowball method
00:26:17.260 | and a total of -- let's see here -- 61 months -- excuse me -- a total of 59 months under
00:26:22.540 | the avalanche method, so highest interest rate first, and a total of 61 months under
00:26:26.820 | the snowball method. So under this scenario, if you were working on this plan, you would
00:26:32.020 | say, "Well, there's not that -- I mean, to me, when the first debt is paid off in 58
00:26:38.140 | months under the snowball method, and then the avalanche method, the first one has paid
00:26:44.780 | off -- the debt has paid off in 47 months, then here the clear winner would be to do
00:26:50.020 | the avalanche under this scenario." Now, I want to be fair to Dave Ramsey. This is not
00:26:55.700 | his method. Dave Ramsey's method, if you listen to his show and absorb what he says, his method
00:27:01.940 | is you should have a target payoff of being able to pay off your debts in basically around
00:27:08.220 | two years -- one year, two years, three years. And his goal for doing that, what he would
00:27:13.380 | say is sell the car, get rid of that $15,000. Now you've dropped your balance from -- total
00:27:19.180 | balance is from $45,000 to $30,000, and then sell a bunch of other stuff and just make
00:27:24.060 | sure that you're on a plan, get an extra job, make sure you're on a plan to get things paid
00:27:28.660 | off in about two to three years. So that would be his plan. So let's figure out what would
00:27:35.100 | be the cost under this scenario if we did it that way. So I'm going to up my monthly
00:27:39.140 | payment, and let's just see how -- I'm going to keep my strategy under the snowball, and
00:27:42.900 | I'm going to up my monthly payment to $2,000. Well, now if I up my monthly payment to $2,000,
00:27:48.820 | which would be $1,100 higher than my minimum payments of $900, now under the snowball method,
00:27:54.300 | I can pay off my debts in 27 months. It would be the longest one paid off, 27 months. So
00:28:00.460 | I'm paying them off, and my total interest at $2,000 -- if I can make $2,000 level payments
00:28:05.940 | towards my $45,000 debt, in 27 months I will have paid off all of the debts, and I'll pay
00:28:11.700 | a total of $7,494.42 of interest under the snowball method. If I do it under the avalanche
00:28:19.540 | method, then my total interest payments would be $4,986.27. So again, that interest savings
00:28:32.180 | that I would enjoy by paying this in the highest interest rate first, I would save $2,508 of
00:28:40.340 | interest. Well, let's look under this scenario. Let's look and see if I would be able to harness
00:28:44.760 | the power of the big wins, the quick wins. Under the avalanche method, I would have my
00:28:51.260 | first debt paid off in 14 months, and under the snowball method, I would have my first
00:28:55.620 | debt paid off in 9 months. So I would look at that, and I would say, "Am I going to be
00:28:59.660 | extra motivated by having that student loan payment paid off, $10,000, and have that paid
00:29:04.860 | off in 9 months, or am I still going to be motivated to do this for 14 months?" But under
00:29:10.500 | the avalanche method, I have my full debt paid off in 25 months versus 27 months. So
00:29:16.900 | I got five months. I had my first debt paid off five months sooner, but it took me two
00:29:21.740 | months longer under this scenario. So which was better for me? Now again, I want to be
00:29:27.820 | fair about this. I have constructed this chart using three loans, and I've made my highest
00:29:34.620 | credit card balance have the highest interest rate. Then my medium-sized car loan, $15,000,
00:29:39.580 | have an 8% interest rate, and then my student loans have $10,000 balance, have a 6% interest
00:29:44.540 | rate. So I don't think I'm constructing a straw man here. I think this is an accurate
00:29:50.060 | analysis, but I have tilted the odds in the favor of this math to illustrate how the math
00:29:54.900 | would work. So this would be the Dave Ramsey plan, because I am paying $2,000, and I have
00:30:00.900 | my debts paid off in 27 months. So this would be under the snowball. But to me, this would
00:30:07.500 | be a good example. If this were the scenario that someone were facing, this would be a
00:30:11.620 | good example where I would say, "Save the $2,500 of interest and make sure that you
00:30:18.260 | pay off the credit cards first, because 14 months versus nine months, is that really
00:30:23.020 | going to make a difference?" Now, again, if somebody had a $300 debt, well, yeah, get
00:30:28.100 | rid of the $300 debt. That would make a lot of sense to me. But this is why it's so difficult
00:30:34.220 | to -- why we have these stupid arguments in the finance world, when they can be quickly
00:30:40.620 | -- like, we have these stupid arguments about what's better, and you go and you read these
00:30:43.820 | comment threads of thousands of comments. Well, this method worked for me. It's great
00:30:47.500 | that it worked for you, but sit down and calculate it. Use the spreadsheet and calculate your
00:30:51.820 | method and figure out what it is for yourself. You're an adult. You can sit down, and you
00:30:57.940 | can say, "I think that I need some behavior modification." Let me give an example. It
00:31:03.620 | is not stupid, if you're going to go on a diet, to go around your house and say, "I'm
00:31:07.820 | going to throw out all the junk food out of my house, so that I don't have it sitting
00:31:11.860 | there and facing me." It's not stupid. You don't have to say, "I'm supposed to be this
00:31:18.240 | mature adult who doesn't give into temptation." I think that'd be pretty smart. Recognize
00:31:23.400 | these behavioral cues and recognize your situation. So understand it, and then harness the power
00:31:30.140 | of behavior modification. You don't have to go through these things. You can harness the
00:31:36.420 | power of behavior modification for yourself. So don't run from it. Don't just say, "I've
00:31:41.700 | got to be coldly rational." We're not coldly rational people. We're human beings. We're
00:31:45.740 | emotional human beings. But run the spreadsheet and actually do the math and figure out what
00:31:51.180 | your actual better scenario would be. So this would just be an example of snowball versus
00:31:57.940 | avalanche. Now, if I change something, I could change any of these variables and adjust the
00:32:04.260 | interest rate. In fact, I thought about doing that, but I think actually it would just be
00:32:07.740 | two numbers heavy for me to go through. I thought about making some alternative spreadsheets
00:32:13.140 | of different scenarios and showing how these things vary. But the key, I would just say,
00:32:18.140 | is do your own math. And I don't want to belabor the point. I think you get it. Do your own
00:32:21.900 | math. Interest rates do matter. Like it or not, interest rates do matter. You can't just
00:32:29.740 | say it's all about behavior modification and it's all about--and it's--and ignore the interest
00:32:34.940 | rates. Oh, I guess you could say whatever you want. I think it's dumb to say it's all
00:32:39.140 | about behavior modification and interest rates don't matter. And I think it's equally dumb
00:32:43.100 | to say it's all about interest rates and behavior modification doesn't matter. Both of these
00:32:48.620 | are important. So we've got to integrate these into the plan. And remember, just because
00:32:54.060 | something worked for you doesn't mean it's necessarily the same thing that everyone else
00:32:58.140 | should do. It's okay if something worked for you. It's okay for me to say, "I choose to
00:33:03.340 | do this because this aligns with my goals." And it's okay for you to say, "I have different
00:33:09.860 | goals." So just recognize, you know, we're all adults. We have one life to live. Let's
00:33:14.180 | live it and not worry about trying to make everyone else. Just because something worked
00:33:18.180 | for us doesn't mean that's what everyone else should do. If I sound a little bit passionate,
00:33:22.780 | it's because I am. Because I labored under this kind of construct for years of just this
00:33:29.260 | personal finance dogma, "This is the right way. This is the right way." Someday I'll
00:33:33.180 | tell my story on a show. But I mean, Dave Ramsey was a huge influence in my life. I
00:33:36.540 | got out of debt because I read his book, Total Money Makeover. And man, it was a brilliant
00:33:42.180 | behavior modification book for me. And I owe him a debt of gratitude for that. I would
00:33:46.540 | love to -- I've never met him. I would love to shake his hand and just say, "Thank you."
00:33:51.100 | That's awesome. But the problem is that it was totally destructive for me to take and
00:33:55.300 | apply that same thing to everything else, that same thing that worked for me in the
00:34:00.060 | financial planning world. And it took me years to learn, "Wait a second. I've got to be a
00:34:04.580 | little bit -- I've got to have a little bit more finesse with this." And then I just -- the
00:34:12.740 | dogma is not necessary. We've got to find a way to implement the -- to bring in the
00:34:20.740 | reality of behavior modification and inspiration without this like divisive, "This is the only
00:34:28.020 | right way." Why don't we teach -- that's what I'm trying to do. Why don't we teach people
00:34:31.020 | to think about it and be adults and think about and create your own plan instead of
00:34:36.060 | saying, "This is what you've got to do because this is right." Run the math. We ought to
00:34:39.340 | run the math on every single situation. And yes, we are doing math. And yes, personal
00:34:45.460 | finance is about finance. It's also about personal behavior and we -- but we are doing
00:34:51.020 | math. This does matter. So I want to go on and hopefully that's not too -- hopefully
00:35:00.460 | that's not too -- I'm not bitter. It's just -- the answer is every -- the answer in every
00:35:06.420 | situation will reveal itself when you actually sit down and create a spreadsheet or get out
00:35:10.980 | a calculator and calculate it. And this is the weakness is that a lot of times as financial
00:35:17.380 | people who are interested in finance, we're not taking the time to learn how to calculate
00:35:21.500 | this stuff. And so we spout what we've heard other people say that makes sense without
00:35:27.420 | sitting down and saying, "Let me challenge it." And if we would challenge people, you
00:35:30.780 | know, don't ever take -- if I do a financial plan for you, don't ever just take it at face
00:35:34.180 | value. Challenge it. You need to understand what's going on in it and I need to be able
00:35:37.740 | to defend it. And if we would learn to challenge things instead of just simply saying, "My
00:35:42.260 | guru says such and such," we may have a slightly better situation. We may have better teachers
00:35:48.660 | because we hold them accountable. We may hold our politicians accountable instead of lying
00:35:52.540 | every day and saying what they're doing and then they just do something else. And we may
00:35:57.100 | actually have a better situation if we would increase our knowledge a little bit and increase
00:36:02.160 | our capacity and our ability. And in a world where with a quick Google search we can turn
00:36:07.300 | up a spreadsheet then we just enter everything in and say, "Let me calculate it," this would
00:36:11.620 | be an amazingly -- this is a valuable thing to do. So let's calculate it. Moving on. Terms.
00:36:18.260 | Interest rates matter. Amounts matter. But terms matter. So in my simplified example,
00:36:25.140 | I have a credit card, a car loan, and a student loan. But here's where you have to kind of
00:36:30.300 | look and say, "What are the actual terms of these debts?" And I cry sometimes when I see
00:36:35.320 | people make serious errors in paying off their debts. Serious errors. So remember, I said
00:36:42.920 | that this -- the whole debt conversation is predicated upon the idea of what's the alternative
00:36:48.820 | use of the dollar and the alternative use of the dollar being consumption. So yes, if
00:36:52.460 | you're going between consumption versus debt payments, you're probably better off paying
00:36:56.020 | off the debts. But what if this is not the question? What if the alternative use of the
00:36:59.960 | dollar is not consumption? What if the alternative use of the dollar is investment? Well, now
00:37:04.200 | we got to look at the terms of the debts and factor this in and we need to do a slightly
00:37:08.760 | more rational analysis. And so this is where -- I mean, this is what in my experience rich
00:37:15.880 | people do. You need to think about this. So let me give you some ideas that generally
00:37:19.280 | are not talked about. First of all, don't just look at the interest rate. Look at the
00:37:24.040 | fact of is the interest deductible or not? Deductibility matters. Deductibility matters.
00:37:32.320 | Now, you may or may not be deducting it. So for example, home mortgage interest deduction,
00:37:36.120 | you may indeed be taking a standard deduction on your taxes and not deducting your home
00:37:39.840 | mortgage interest. However, that's not the only thing that's deductible. Are you deducting
00:37:44.840 | your student loan interest? Are you deducting this as a business interest? First of all,
00:37:50.320 | don't be dumb and ever borrow money that's not deductible. And I say it again, don't
00:37:55.520 | be dumb and ever borrow money that's not deductible. Listen to my show and I'll teach you all the
00:37:59.160 | ways to borrow money that's deductible, but don't ever -- this is why the gap between
00:38:05.480 | the rich and the poor gets bigger, is that poor people borrow for consumptions. They
00:38:09.600 | borrow on a credit card at a high interest rate and it's non-deductible interest. They
00:38:13.360 | borrow on a car and it's a high interest rate and it's non-deductible interest. And they
00:38:17.880 | borrow on a house, but their income is such and the house is so low as far as the amount
00:38:23.640 | of interest that they're paying on the house payment, that they're better off just taking
00:38:26.800 | the standard deduction. They'd be better off just renting probably, most of the time. And
00:38:31.360 | so you're wasting this deduction. So -- but wealthy people would say, well, let me make
00:38:36.960 | sure that I'm borrowing and if I'm borrowing it's going to be on a business credit card,
00:38:40.280 | so therefore my interest would be deductible. If I'm borrowing and paying interest on a
00:38:44.120 | car loan, let me make sure that at least some portion of that car loan is being paid by
00:38:49.040 | business, so that it's deductible. And let me make sure that my home mortgage, if I'm
00:38:53.080 | going to go ahead and do that out, let me make sure that I go ahead and maximize that
00:38:56.640 | deduction. So I don't think it's -- I wouldn't -- I don't think it's smart to go into debt
00:39:01.560 | for the purpose of deduction, but if you're going to go into debt, make sure that you're
00:39:04.440 | going to deduct it. And don't -- and let -- and this stuff matters. And this is a major, major
00:39:10.240 | factor in financial planning. You've got to look at the deductibility of the interest.
00:39:17.240 | Now, give me an example, okay? The mortgage is the simple one. If you are deducting your
00:39:23.760 | mortgage, you would run the analysis. If you are deducting your mortgage interest, you
00:39:28.200 | would run the analysis and see, you know, for example, are you close to the standard
00:39:31.840 | deduction line? If you're close to the standard deduction, you can just use the standard deduction
00:39:35.480 | instead of itemizing your deductions, that would be fine. You may choose to go ahead
00:39:40.120 | and pay off the mortgage. But you may, if you're in a higher tax bracket, there's no
00:39:46.960 | question of the fact that if you can subsidize -- let the tax code subsidize your mortgage
00:39:53.120 | interest, that can be a substantial savings. If you're in a marginal bracket of 25, 28,
00:39:58.920 | 30-something percent, then the -- a 30 percent discount on your interest can be a substantial
00:40:07.200 | interest deduction. If you go from 4 percent, that drops you down to 3 percent. That's a
00:40:11.360 | substantial savings as far as allowing the tax code to subsidize you. What about something
00:40:17.520 | like if you're going to borrow money for a business -- if you're going to borrow money
00:40:22.600 | on a car and you do that in your business versus not? Let's say that you're self-employed.
00:40:27.080 | Look at the savings that you have with the deductibility of business interest versus
00:40:30.520 | not. Let's say that you have purchased a car and your interest rate is 5 percent on your
00:40:38.720 | loan. Hopefully you got good credit and you can get it much lower than that. But let's
00:40:42.880 | just say 5 percent for an easy example. If you're in a marginal bracket -- I'm just going
00:40:47.240 | to use 28 percent. Let's say you're in a 28 percent marginal bracket and you're self-employed.
00:40:52.120 | So you're also paying -- I'll just use self-employment taxes instead of employment taxes because
00:40:58.160 | they're just simpler. So you're paying 15.3 percent of self-employment taxes. So your
00:41:03.800 | savings on that loan is 15.3 percent plus 28. So you have a 43 percent discount on that
00:41:12.680 | interest rate because of the fact that you are able to deduct the interest. So if your
00:41:18.360 | interest rate were 5 percent, then you would lower that by 43 percent and that's what your
00:41:23.120 | effective interest rate is. That's a substantial discount. You've got to factor that in because
00:41:30.480 | when you can get a 43 percent savings on your interest rate and if you can borrow money
00:41:35.320 | under reasonable terms, you've got to factor that in. That does matter. So you've got to
00:41:40.840 | look at that. And let's say under this scenario -- and here's why I bring it in in the debt
00:41:45.720 | scenario. In this scenario, if you're advising a client, if you're a financial planner, or
00:41:49.800 | if you're just advising -- you're just coaching yourself, if you have an asset that has a
00:41:55.520 | loan on it under the business loan and you have personal debt, then this is going to
00:42:01.640 | dramatically affect your specific debt payoff plan. And you better prioritize that -- I
00:42:09.960 | would recommend that you prioritize that personal debt over and above the business debt and
00:42:16.920 | continue to enjoy the subsidy on your business debt. It exists for a reason. Remember, Congress
00:42:22.480 | -- all this stuff exists for a reason. You're supposed to be being incentivized to go out
00:42:27.480 | and borrow money to expand your business. So why not take advantage of that? Now, you
00:42:31.640 | may still want to pay off that debt. If you get to the point where you say -- again, I'm
00:42:36.720 | not arguing today what debts you should pay off and shouldn't pay off. I'm just arguing
00:42:40.080 | about the order. And that if somebody has -- if you're doing this snowball thing where
00:42:45.560 | you've got -- I've got a car loan in my business over here that is a small amount. I've got
00:42:51.760 | to put that first. No. Focus on the deductibility of the debt versus the non-deductibility.
00:42:59.880 | Focus on the actual makeup of the interest. So, for example, is this fixed interest or
00:43:04.120 | not? So take a look and figure out what you should actually choose to do under the interest.
00:43:12.020 | So is the interest rate fixed or is it not? And depending on what the makeup is of your
00:43:16.320 | debt, you may have different options. I would heartily suggest if you can ever refinance,
00:43:21.640 | always look to refinance your debt. Now, again, you need to do the math to make sure that
00:43:26.520 | it's in your best interest. So if there's a cost to refinancing the debt at a lower
00:43:30.320 | rate -- so, for example, let's say that you're surfing credit card balances and they say
00:43:35.320 | we'll allow you to do a balance transfer to a lower interest rate, but we're going to
00:43:38.920 | charge you a percentage of the balance. Because you're actually doing math and not just blindly
00:43:44.300 | following someone else's plan, look at your spreadsheet and calculate and see how much
00:43:53.080 | is this actually going to be worth it. By the time the debt's paid off, am I actually
00:43:55.800 | going to save on interest? So always try to figure out can I surf the interest around?
00:44:00.380 | And sometimes you may choose to refinance variable interest rates over to fixed interest
00:44:05.400 | rates, and you may choose to refinance fixed interest rates over to variable interest rates.
00:44:10.200 | Sometimes a fixed rate mortgage will make sense. Sometimes a variable rate mortgage
00:44:13.360 | will make sense. Sometimes -- just look at this and figure out the interest rates. Look
00:44:19.760 | at the fact of is this a secure debt or not? So if I had two equal debts, let's say that
00:44:24.920 | I had a credit card balance of $20,000 and let's say that I had a car balance of $20,000,
00:44:32.080 | and if I were sitting there looking at them and if they had equivalent interest rates,
00:44:36.160 | which is a big if, because a lot of times a credit card balance, especially if someone
00:44:39.480 | has poor credit, will have a much higher interest rate than a car loan. But let's assume I have
00:44:43.480 | good credit and I have a 0% credit card and I have a close to 0% car loan or something
00:44:51.060 | like that, then I personally would consider paying off the secured debt first. Because
00:44:57.580 | in doing planning for disasters, if I wind up in a situation where I lose my job or if
00:45:02.880 | I wind up in a situation where I have a business shortfall for six months or if I wind up in
00:45:07.440 | a situation where I get sued or I face financial trouble, I want to make sure that I don't
00:45:14.980 | lose my car. And so I'd rather have a paid-off car and have a credit card balance, and then
00:45:19.620 | if I fall behind on my payments, then I just say, "Sorry, I've done my best, but I can't
00:45:24.020 | do any better." I'd rather have a paid-off car than a paid-off credit card. So think
00:45:28.420 | about that and look at your situation. Now, if my credit cards are at 18%, variable interest
00:45:33.980 | rates, and my car loan is affixed at 3%, I probably would choose not to do that because
00:45:39.960 | the cost is much too high as far as the interest, so I'd go ahead and pay off the credit cards
00:45:44.220 | first. But this is why you have to look at your actual situation. I would look at, is
00:45:48.780 | this debt bankruptable or not? So if worse came to worse and I were forced to declare
00:45:53.460 | bankruptcy, which I think is a very important aspect of financial planning that we don't
00:45:59.020 | do, risk management planning, do bankruptcy planning. What if the worst came to worst,
00:46:03.300 | my teenage daughter hit somebody and it was her fault and I got sued and I didn't have
00:46:08.460 | the proper insurance and I were forced into bankruptcy by my lawsuit? Well, is my debt
00:46:13.580 | bankruptable or not? So here the example would be a student loan is not bankruptable, whereas
00:46:20.620 | a credit card balance probably would be, especially if that credit card balance were a business
00:46:25.060 | credit card or a car loan would depend. So a personal loan probably would be bankruptable
00:46:32.140 | or another loan would be bankruptable. So if I were looking and let's assume that in
00:46:40.620 | my plan I have a student loan balance at an equivalent interest rate of a credit card
00:46:46.940 | balance, then I may choose to go ahead and pay off the student loans knowing that, again,
00:46:52.740 | same thing, the credit card is unsecured and it's bankruptable, whereas the student loan
00:46:57.380 | is also unsecured but it's not bankruptable. So I guess, I don't know, technically that
00:47:02.380 | wouldn't be unsecured, but it is secured in a sense. They can always come after you for
00:47:06.900 | that amount of money. Or if I were looking and I was saying I've got a mortgage that
00:47:11.460 | I'm interested in paying off and this mortgage has a similar interest rate to a car loan,
00:47:19.020 | then I may consider going ahead and choosing to pay off the mortgage more quickly because
00:47:23.180 | at least in my state we've got great bankruptcy protection laws because then I wind up in
00:47:27.540 | a situation where my house would be debt free and this would be a valuable aspect of my
00:47:33.380 | asset protection planning. So, I mean, does this matter? I think it does.
00:47:39.540 | You know, I've worked with various physician clients and I would say if I had – again,
00:47:44.580 | depends on the terms. You've got to look at the terms and you've got to run the math.
00:47:47.820 | Would I be willing to pay off a 3 percent fixed rate mortgage on a house in a scenario
00:47:53.140 | where I were facing 18 percent credit cards – 18 percent interest on my credit cards?
00:47:59.060 | No, I probably wouldn't. And I probably actually wouldn't – and I wouldn't prioritize
00:48:02.140 | paying off the house. I'd prioritize fully funding retirement plans which are also credit
00:48:06.540 | or protected. So – but you've got to factor this in. Consider it.
00:48:13.380 | Consider can I refinance this debt? So again, if you know that you have credit card debt
00:48:20.780 | and it has small balances but you know that you're able – because you have a good
00:48:25.580 | credit score, you're able to refinance the debt and keep it on zero percent credit cards
00:48:29.480 | under the terms and you're expecting that you're going to be able to refinance that,
00:48:32.900 | then you may go ahead and prioritize the student loans that you can't easily refinance at
00:48:37.540 | the higher rate. That to me would be an important thing to consider and always be looking to
00:48:41.860 | say what can I refinance here, what can I refinance there.
00:48:46.220 | What are the – one thing I forgot to mention, I wanted to mention on kind of the – is
00:48:50.660 | this debt secured or not. What about things like 401(k) loans or life insurance loans?
00:48:56.980 | I would prioritize repaying a 401(k) loan or I would prioritize repaying a life insurance
00:49:02.240 | loan before I would prioritize paying an unsecured credit card because again, same type of thing.
00:49:09.920 | My 401(k) loan, if I had a 401(k) loan or if I were working with a client who had a
00:49:13.560 | 401(k) loan which they're not a good plan, I would recommend not pursuing that path.
00:49:18.120 | But people pursue it and it's there for a reason.
00:49:20.480 | So if you have a 401(k) loan, I would recommend prioritizing the repayment of that so that
00:49:27.580 | you can restore the balance of the account to the investment earnings so that you could
00:49:32.540 | be protected in case you lose your job and so that you can restore the asset protection
00:49:36.820 | nature of the 401(k) and again, look at the terms. What are the terms of the 401(k) loan
00:49:42.180 | versus the credit cards? But I would much rather do that or pay back a life insurance
00:49:45.940 | loan that I'm being charged interest on by the life insurance policy. I'd much rather
00:49:50.980 | pay that back and restore that balance and restore that in a creditor-protected world
00:49:57.300 | than pay back a credit card that I have at 2.99% first. I mean, I would do that first.
00:50:04.200 | So consider that.
00:50:05.200 | And then the last thing would be what is the makeup of this debt? Is this consumer debt
00:50:09.060 | or is this investment debt? And now again, I recognize that many people who are listening
00:50:14.580 | to financial shows or reading financial blogs, kind of at the initial level of financial
00:50:22.540 | awareness is get rid of consumer debt. But consumer debt is not the same thing as investment
00:50:28.860 | debt. So look for a way to refinance things and take advantage of investment debt. So
00:50:36.260 | if I had consumer debt that I couldn't figure out a way to refinance and keep it as consumer
00:50:42.060 | debt, then I would go ahead and I would look at doing a margin loan on a stock account.
00:50:47.780 | And then I could -- or depending on what assets I have and depending on how it's structured
00:50:52.660 | and depending on the terms of the loan. But if I can take out a margin loan on a taxable
00:50:58.380 | account and use that to pay off my consumer debt, then now I've converted that from a
00:51:03.220 | non-deductible consumer debt over to a deductible debt, which is deductible against my growth
00:51:09.100 | in my investment account. So that helps to offset my taxes on any gain in my taxable
00:51:16.060 | account. So there's a variety of ways of looking at this. And again, I just would plead that
00:51:22.420 | we do a better job of thinking it through. So I think those are the primary things that
00:51:28.860 | I wanted to communicate today. I hope this show is interesting. And I hope that this
00:51:32.500 | can provide some ideas. And these are just ideas that I've thought of over the years
00:51:35.940 | as I've looked at client situations. And again, my major premise is that we will be far better
00:51:42.460 | served by individually looking at client situations or individually looking at our friend's situations
00:51:49.540 | or people that we're helping with their money rather than just simply saying, "This is what's
00:51:55.480 | always right." It is useful to teach things through. It is useful to teach, "Here's what
00:52:03.020 | a snowball method would be. Here's what an avalanche method is." And sometimes I forget
00:52:07.140 | because I have gotten astonished many times in working with clients. And I think, "Why
00:52:12.940 | are you doing this?" When I see people doing the little extra here in their method, I just
00:52:18.580 | think, "Why are you doing this?" But I can help those people and you can help those people.
00:52:24.420 | Sit down and help build out a spreadsheet. And the last thing I love about this spreadsheet,
00:52:28.380 | I encourage you, if you've never done this for yourself or if you've never played with
00:52:31.620 | these numbers, go to the link in the show notes and download the spreadsheet and put
00:52:35.620 | some numbers in and play with some scenarios because you need to play with the scenarios
00:52:39.740 | to see the cases in which a snowball would make sense and an avalanche would make sense.
00:52:43.620 | You want to calculate what is the actual interest that's paid. I've done this sometimes for
00:52:50.620 | clients and I've done lots of these spreadsheets. And many times, the makeup of the debts and
00:52:57.420 | the amount of interest that is--and the interest rates, you look at it and say, "Look, you've
00:53:02.700 | got an extra $332 of interest if you pay the highest interest rate first instead of the
00:53:07.900 | lowest balance first." You absolutely, in my opinion, in that scenario, you should go
00:53:11.900 | with the lowest balance and you should make sure you harvest this behavioral win. On the
00:53:16.620 | other hand, look at it and say, "How can I harvest the behavioral win? How can I harvest
00:53:22.780 | the interest rate savings? And how can I keep these other factors in mind that I've mentioned
00:53:27.340 | of the terms of the debt?" And what the thing I like about this spreadsheet, you can put
00:53:32.100 | it in as in a custom order. So you would enter in, "Okay, I'm going to do this one, this
00:53:36.020 | one, then this one, then this one," and then you can compare it to your baseline, whatever
00:53:39.700 | your baseline is. If your baseline is highest interest rate first, and you can see, "Here's
00:53:43.100 | how many months to pay this off. Here's how this will work. And here's how I can really
00:53:48.220 | answer this. I can really--you know, here's what my total cost will be." So play with
00:53:53.500 | the numbers. I hope that you enjoy this chart if you've never found one like this. It's
00:53:56.820 | the most useful one because it's the most visible. Quick tip for you, make sure you
00:54:01.580 | look at the first page, which is the calculator, and the second page, which is the payment
00:54:05.660 | schedule. And the nice thing about the payment schedule is you can add in additional payments
00:54:10.820 | using the debt payoff nomenclature. This would be called debt snowflakes. So you can say,
00:54:15.540 | "Okay, let's assume that I have an extra Christmas bonus of a thousand bucks. What if I pay a
00:54:21.940 | one-time extra bonus of a thousand bucks on Christmas?" And you can plop that in on the
00:54:25.900 | second sheet of this chart, which is the payment schedule. And I find that to be a really useful
00:54:31.260 | tool. And I guess the last thing is--that I have is I find this--I have found this chart
00:54:37.380 | to be incredibly motivating for clients and motivating for me as well. And paying off
00:54:42.260 | debt can be very motivating for people when they can see how it works. Debt is such a--paying
00:54:47.540 | off debt is such a tangible, powerful goal. This is why it's so actionable, is because
00:54:54.060 | it's such a tangible goal. You know there is a clear finish line. Getting wealthy is
00:54:59.780 | less of a powerful goal because there's--what's the finish line? What's the number? And that
00:55:04.700 | number changes all the time and that's why it's so powerful to harness this behavior
00:55:09.420 | modification of paying off debt. I don't think ultimately paying off debt is necessarily
00:55:13.860 | going to make someone happy because you still got to figure out the lifestyle factors. But
00:55:18.420 | it certainly can be--is an important step on the road to get there. And I hope you like
00:55:26.980 | this--I hope you like this chart. I found that when I've done this for clients and given
00:55:30.780 | it to them and allow them to play with the numbers. And what I do, just a final quick
00:55:35.260 | tip is I go through the cash flow statement and I say, "Okay, look." And I use this side
00:55:41.340 | by side with the cash flow statement. In many ways, this debt spreadsheet, if someone is
00:55:45.740 | in debt, this--I view this as kind of a third statement, a statement of liabilities if you
00:55:50.740 | want to be precise. And what we do is we go through the cash flow statement and we mark
00:55:56.500 | some changes. And we say, "Okay, if you were going to adjust this area of your cash flow,
00:56:00.460 | okay, you're going to--let's say that, you know, a simple one, you're going to cut your
00:56:03.460 | cell phone bill. Okay, you're going to cut your cell phone bill, then you're going to
00:56:06.340 | make this change and so therefore there's an extra 50 bucks. And so now if we go from,
00:56:11.220 | you know, $2,000 of payments, we go to--or an extra $100 a month, that would be easier.
00:56:15.260 | So now we go to $2,100 of payments. Then in my little scenario I've got sitting in front
00:56:19.900 | of me, at $2,000 a month using the snowball, then this person was out of debt in 27 months.
00:56:26.940 | At $2,100 a month, then this is out of debt in 25 months. And so now we can figure out
00:56:32.460 | the opportunity cost and we can bring it into an opportunity cost and say, "Would you rather
00:56:37.580 | have the fancier cell phone with the--and pay the extra $100? Would you rather be out
00:56:42.420 | of debt two months sooner and save--" Let's see what's the difference, $7,100 of interest
00:56:47.060 | versus--let's look here, versus $7,494 of interest and save the $300 of interest and
00:56:54.340 | be out of debt with the balance two months sooner. And there's no right or wrong, you
00:56:57.980 | know, it's all a matter of choices. We all have tradeoffs, we all have choices and this
00:57:01.940 | is life. We're adults, we can choose for ourselves what we prefer. In one answer, one scenario,
00:57:07.780 | the question may be, "Yes, I would prefer that." And the other question may be, "No."
00:57:11.420 | And now we have some numbers that we can put behind it. And these numbers, I think, are
00:57:16.460 | valuable. So that's our show for today. I hope you enjoyed it. I hope I didn't come
00:57:20.180 | across--I hope I didn't come across as too strong. I really am a nice guy and I'm not--I
00:57:24.740 | just--I guess I'm just sharing, you know, some of the things that I have learned and
00:57:30.100 | working with clients. I just--I want to--I want us to raise the level of our advice for
00:57:35.060 | ourselves and for others. Let's take it up a notch. Let's get a little more professional.
00:57:38.940 | Let's understand a little bit more. And if someone gets motivated just by a debt snowball,
00:57:44.220 | that's awesome. But at some point--but I just hate to see people make mistakes that cost
00:57:49.540 | them because they don't know how to calculate the impact. You know, when I see somebody
00:57:54.260 | cash out a 401(k), pay the penalty in interest and do this to pay off a debt that's low interest
00:58:00.540 | rate, I just look at it and I say, "Arr, did you actually run the cost of that?" If you
00:58:05.140 | did and you made that decision, it's your money. But man, that's an expensive decision
00:58:09.660 | sometimes. And look at the lost power of the money that you would have had, the lost compounding
00:58:14.260 | that you would have had if you had done it, if you had continued, you know, if you continued
00:58:18.660 | on the plan. So, hopefully this is a useful resource for you. I wanted to create it as
00:58:23.740 | something I could point people to so that they're helping--so that you can kind of guide
00:58:27.780 | yourself through what order should I pay things off. I hope it's a useful resource for you.
00:58:32.460 | That's it for today. Thank you for those of you who are leaving reviews for me. I would
00:58:36.260 | ask you, please, if you haven't done so, I would just solicit--if any of this information
00:58:40.340 | has been helpful or if you've enjoyed it, I would solicit a review in iTunes from you
00:58:44.740 | or Stitcher or whatever you're listening on. I would just--that would help me so much and
00:58:48.500 | I would appreciate that. So, I just ask you for that and I would say thank you. Also,
00:58:52.540 | if you're not subscribed to the show for the show notes, come on by the blog at radicalpersonalfinance.com,
00:58:57.780 | enter your email address that I won't spam you. I would just send you the show notes
00:59:01.820 | every day so that way you can see the full show notes of the show and you can understand
00:59:06.380 | what the show will be out and you can see if it's something that you're interested--see
00:59:08.980 | about and you can see if it's something that you're interested in or not. So, come on by
00:59:12.780 | the blog, leave me a comment, shoot me an email, let me know what you thought of the
00:59:15.220 | episode. Today was radicalpersonalfinance.com/32 and I am out. Enjoy your Thursday.
00:59:22.220 | Peace out, y'all.
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