Are you £1 ahead or £1 behind?

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I was reading an excellent post over at Seth Godin’s blog which got me thinking about budgeting, wealth and financial independence.

The article talks about how over 2 billion people on this planet live below the poverty line. Now for one moment, the chances are that if you are reading this article, you are not living in the abject poverty being suffered around the world but you could be in a state of personal financial “poverty”.

Do you spend more than you earn? Does more money float out of your bank account each month than flows in?

If you spend just one more £1 than you earn each month, you will get further and further into debt. If you spend £1 less than you earn each month that is £1 extra put in reserve.

To achieve financial freedom in your life time you need to spend money only on necessities, and save for a later time, when you can afford to buy luxuries.

Actions:

1. Prioritise your debts – pay those carrying the higher interest rates first

2. Draw up a cashflow forecast – see how your money comes and goes each month over the next 12 months.

3. Prune all those “luxuries” you don’t need – e.g. possibly downgrade on your satellite or cable package, cancel that gym membership you never use.

4. Destroy those credit cards – only use cash for purchases – open a separate savings account for those large, one-off purchases you need to make each year.

5. Live by the mantra, “10% of all I earn is mine to keep forever”.

What else can I add to this list – please comment below.

Credit Cards – 0% on Balance Transfer – interesting article

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I just read a very interesting article on balance transfers over at Rob Lewis’ Money Watch site.

Many people have built up outstanding balances on credit cards over the last few years, using their cards to meet day to day living costs, as well as more expensive purchases.

What many don’t realise though is that they do not have to keep the balance of their card with that same provider. By “transferring” to another credit card it can be beneficial in terms of maybe a discount or 0% interest charge for a period of time.

With Bank of England Base rates so low at the moment, and with the slow down in economic activity many people are feeling the pain in terms of the interest rate they are being charged for the outstanding credit card balances.

If you have several credit cards with outstanding balances then check out our “debt snowballing” article

Debt-snowball – repay your debts quicker

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Debt-Snowball – Repaying your Debts Quicker

It is common for people to have more than one debt – for example you may have a mortgage, a personal loan, a few credit cards, hire-purchase etc. Nobody likes debt, unless it is being used as leverage for an investment, and for the majority of people the quicker it is paid off the better!

Snowball those Debts

Consider a hypothetical situation whereby you have say 3 debts as shown in the following diagram –

debt-example

In this example the borrower owes a total of £105,600 and is paying £759 per month for this benefit. There have been other methods mentioned on the internet whereby you effectively repay the smaller debts first. I can understand the psychology of this approach – it is easier to cope with one large debt than several smaller debts. In the example above, any surplus funds would be used to pay off Credit Card 2 first – this debt could be cleared fairly quickly based on the amount remaining outstanding and in terms of “cost” it carries an interest rate of 16% making it the second most expensive debt.

The Logical Approach to Debt Repayment

Regardless of the amount of debt outstanding let’s focus on the Interest Rate.

The interest rate tells us the “cost” of owing that amount of money. For example, with Credit Card 1 the interest rate is 19% – therefore for every £100 that we owe to that lender they will charge us £19 for those 12 months – it’s as simple as that.

To demonstrate the logic of this, consider a situation where you owe £100 to each of Credit Card 1 and Credit Card 2 in the above example – Credit Card 1 is “charging” you £19 per year for this privilege and Credit Card 2 is charging you £16 per year. If you had £100 available to repay one of those two credit cards which one would you choose? Logic dictates you repay the more expensive one first.

Conclusion

Therefore, the logical conclusion is to check all your debts and see how much they are costing you each year – check carefully as interest rates have a nasty habit of increasing beyond what you THOUGHT you were paying over time. Once you have drawn up a “league table” maximise all efforts to repay your most expensive debt first, making just minimum payments on the remaining debts – as soon as the first (most expensive) debt is paid off move on to the next one.

Action

Make a list of all debts and interest rates – make a concerted effort to repay the most expensive ones first. Maybe consider transferring any outstanding balances from higher charging credit cards to those with a nil or lower introductory balance allowing you to make greater savings and, thereby, repay your debts quicker.