Question: Hi Rose, I’ve read your articles about FQ. Kindly advise us how we can be free from indebtedness. Thank you. – Anonymous via text message
Answer: Freedom from indebtedness: this is the dream of people who are aspiring for financial happiness. I like reading (and writing) articles that enumerate things or steps but I think it’s always best to start with the right framework, so that when we start our course of action we are properly guided.
Maybe it’s good to begin by pointing out what debt is. The dictionary defines debt as something, typically money, which is owed or borrowed. This definition connotes that it is something temporary and should be given back to the one you borrowed it from. Another way of looking at debt is it’s a privilege. And I think that is why the other word for debt is credit, which also means praise (as in “Give credit where credit is due.”) or what we call as pogi points. Now why is credit or debt a privilege? Because it allows you to make use of a sum of money, which is not yours, of course, with the agreement that repayment will be made. It is a privilege extended to you because of a certain level of trust and a positive assessment of your eligibility – i.e. your creditworthiness.
There are good debts and there are bad debts. And a general rule that we can apply to know if a debt is good or bad is to ask the question, “Will the purchase I’ll make using this debt increase in value and bring me to a better financial condition?” If the answer is yes then you can say it’s a good debt (provided the loan terms and conditions are good). An example is a housing loan. Your financial condition may be improved in the future as you are not just able to give your family a home but this asset may even increase in value.
This is not true for purchase of things like clothes, unnecessary gadgets, vacations (click link to read an article about this) and other consumables that we can easily buy with the use of the credit card (click link to read an article about this). Accumulation of a lot of bad debts is abuse of credit privilege.
Now what happens when you abuse this privilege? It brings you to a miserable life of being shackled to debts. Now the roles reverse. Whereas, the debt is supposed to empower you, now you become the slave of the debt. And I suppose this is how you feel now and that’s why you want to be free from debts. The good thing is you are already aware that you want to be free from your debts. Realization of the problem and the commitment to solve it are the two most important steps to your freedom.
You may now proceed to do the following:
- Make an inventory of your debts. Take note of those with high interest rates and the past due ones. Write down across the debtor’s name the purpose of your loan. Did you purchase a luxury item you can’t afford? Did you pay your child’s tuition, which you forgot to save up for? Did you pay up another loan? Did you throw a party way too expensive? Now, if it’s a huge credit card debt you may just write consumables. You may also write down the major items in the bill.
- Go through each loan and recall the experiences. It may be painful to do this but I think it’s important to understand yourself why you got into this situation. What were you hoping for? Did the purchase really make you happy? Was it worth the misery you’re in now?
- If you still don’t have a monthly budget, make one then list down your actual expenses for one month. Be very honest and note all the wants here. Starting today get rid of all wants expenses. (Note: You may get back to spending for wants once you’ve completed your Emergency Fund and have started your Retirement Fund. I know I sound like a strict teacher.) Prepare your Needs Budget and stick to this. What amount can you use for your debt repayment? Commit to use this amount for the sole purpose of debt service.
- Stop using your credit card. Just use cash. If cash runs out, that’s it, wait for the next cash inflow. Avoid going to shopping places. Avoid Sale events like the plague. You have to plug the holes.
- Make an inventory of all the items in your house. What can you sell? Maybe some of those you bought on credit card can be sold. Be ruthless, and get rid of everything you’ve accumulated which you don’t need. Use the proceeds for debt service.
- Make a plan. Give your debt repayment a timetable. The idea is to retire your debts as soon as possible. Use your garage sale proceeds and your monthly debt service to pay out your debts listed in your Debt Inventory. The ideal is to retire those with the highest interest rates so as to save on interest payments. But check if some of your debts (especially from family and friends which are interest free) are already as old as your firstborn. It may be good if you also prioritize them. Remember, those lenders granted you a privilege and it’s just right that you pay them back. The loans may not have an interest cost but may have a high social cost – i.e. have your relationships with them turned sour?
- Once your loan repayment plan is in place, call your creditors and inform them about your intention to fully pay your loans. It may be good to do this with a partial payment of your outstanding balance. Then follow through until the loans are fully paid.
- Look for ways to increase your income. As you do, don’t get carried away by increasing your spending. Remember, in Number 3 I said go back to your wants only after you’ve completed your Emergency Fund and started your Retirement Fund. Always remember the lessons you learned from this trial so that you will never go through it again.
This will be a challenging journey. But consider it an important learning experience. It’s easier to do this if you’re still single. If you already have children, it may be difficult for you to see your children sacrifice and give up the good things that they’ve been used to. As any parent, I’m sure you don’t want to burden your children with financial problems because you actually owe them financial security while they are your dependents. However, you also owe it to yourself and your children to be truthful about the situation. You have to break it to them gently if it’s the first time you’re discussing financial matters as a family. Try to do away with the dramatics and as much as possible have an optimistic tone that says, “We have a family challenge and let’s all help each other to overcome this.” You might even be surprised with the great ideas that they will come up. Who knows this experience will help them grow up to be better individuals empowered with problem solving skills?
Wishing you freedom from debt and financial happiness,