We often hear the mantra that debt is bad. Still, that doesn’t stop the majority of people from assuming they’ll always have bank payments. For many, using credit to buy vehicles, take vacations, or fund home improvement projects is a normal mindset to make their lifestyle work. They believe that borrowing money to fill income gaps is the solution to sustaining their way of life.
In effect, this puts them on a monetary hamster wheel, which means they work to earn a paycheck and then spend the money they earn to pay bills and make payments to the bank.
This is flawed logic and creates a trap or cycle of continually relying on banks to meet your cash flow needs.
Reset your way of thinking and recover your financial situation
Let’s take a step back and look at the bigger picture when it comes to money. This big picture is actually relatively simple: money is flowing towards you or away from you. If the money is flowing to you, you are in control. If the money slips away from you, you give up control.
This is the problem with the typical conversation surrounding debt, with the focus often solely on debt repayment. And while getting out of debt is important, that can’t be the only goal.
The focus should be on the source of the problem and not just the symptoms. The source of the problem is poor planning (poor cash flow management and financial decision making in silos). The symptom is the debt itself.
If we only focus on the symptom (paying the debt), nothing has been accomplished to fix the problem (poor planning) and that is why focusing on the symptom is a lifetime prescription to stay in the cycle of debt.
Therefore, you must first shift your thinking away from loan terms and how much bank payment you can afford and start moving towards minimizing the percentage of your income paid to banks. By having less money flowing to the banks, you have more money flowing under your control that can be used to build wealth for yourself.
So if you find yourself with money flowing from you to the banks, your goal should be to work immediately to restructure or eliminate those payments. Notice I said payments…not the balance.
How to tell if a loan is “bad”
The first step in this process is to identify the loans that are taking too much of your monthly resources and start working on restructuring them to put you back in control of those dollars so you can focus on building wealth.
One strategy we use to determine if a loan is in your favor or favors the bank is to divide the balance you owe by the minimum monthly payment.
- If this number is less than 50, we consider it a bad loan.
- If the number is between 50 and 100, we would consider that suspect.
- If it is above 100, we consider it a good loan.
For example, a $30,000 auto loan might have a monthly payment of $670. Using our formula, this loan would be assigned a score of 44. This score suggests that the loan is a bad loan and is taking you too far away from your monthly income and is beyond your control.
What should you do about it? One option may be to take equity out of a home to reduce the payment to $143 per month and give it a new score of 209, suggesting it’s a good loan. This strategy moves $527 per month away from the bank and back into your control to focus on building wealth.
Next, itemize your current debt balances and minimum payments. Use the formula explained above to identify the loans that need your attention.
Refinance to regain debt control
Once you have written down this information, the next step is to begin to identify the options available to you to restructure debts deemed uncollectible. This process begins by detailing all of your resources, such as cash, investments, life insurance cash values, and home equity. You will also want to include how much money you put into it each month. This will help you identify how you might be able to tackle your bad debts by focusing your available resources on doing so.
A note on the equity in your home, if you take the value of your home and multiply that amount by 80%, then subtract the amount of your current mortgage, you get the available equity in your home. If you have a positive number, this is equity that you can use to help lower your payment, as previously described with auto loan refinancing.
Your house: You will likely find that refinancing a home to use home equity will be the most successful option using our formula. A residential mortgage often has more favorable rates and terms that allow you to begin to regain control of your cash flow. It’s not about paying off the house; it’s about reducing your bank commitments. Using a 30-year loan is the best loan and results in the lowest payment possible.
Your vehicle: Sometimes refinancing a vehicle can free up cash to consolidate other balances and reduce payments. Again, it’s not about the car loan itself; it’s about solving the problem, which starts with looking at your overall financial situation to determine the best way to pay off the debt you already have to pay. In this case, an auto loan is a more structured and controllable loan compared to a variable rate credit card which also allows you to charge more.
Your student loans: Renegotiating student loans can work if you stretch the balance and focus on keeping required payments as low as possible. When it comes to extending terms, many people immediately start thinking about interest charges and extended terms. This is where utopia collides with reality. If all you have is a student loan and you’re paying cash for automobiles and other big-ticket items, this shouldn’t be your priority. However, the majority of people who have student loans also have car loans and credit card debt. It’s all a set of dominoes where paying off debt for something like a student loan can contribute to having limited resources, forcing other bank loans to make ends meet.
Life insurance: A banking strategy using whole life insurance can work in some cases where there is cash on hand allowing us to use the policy provisions to consolidate debt and control payments. Cash value life insurance policies provide access to loans where the insurance company will use your death benefit and cash value as collateral. These loans come with very favorable terms and, depending on the design of the policy itself, can lead to uninterrupted growth in your cash values.
When you have few options, try the snowball system
Unfortunately, there are circumstances where there is no room for change. For example, if you are maxed out on your credit with little or no resources, there may not be many options available. In this scenario, your best bet is to focus on a debt snowball system, where you first pay above the minimum payment on smaller balances while paying minimum payments on other balances. When a debt is paid off, you use that payment to pay off the next smaller balance, and so on.
Of course, you can take this to another level and start selling stuff, downsizing houses and cars, and getting a second job, which for some people might be exactly what you need to do.
Your long-term debt solution
Every situation is different and you can benefit from using some or all of these strategies. My goal with the information, strategies, and techniques discussed here is to help you realize the need to focus on behavior change so that you no longer use banks to finance your lifestyle.
There are purchases in your past that created the debt you have and if you devote all your resources to paying off those debts, you will find yourself in a continuous cycle of debt. You cannot overlook the fact that you will have future cash needs, and if you don’t plan for them now, you will resort to more bank loans.
By moving more cash under your control and creating a strategic financial plan detailing all major future needs, you can determine how much of your cash flow should be used to pay down debt and how much should be used to meet your future needs.
Getting off the hamster wheel of debt means thinking differently about the purchases you make and how you make them, and redirecting your focus to building wealth.
If you focus on building wealth and having access to and control over the money you have, you will soon find that you no longer need banks to satisfy your lifestyle.
Securities offered by Kalos Capital Inc., member FINRA/SIPC/MSRB and investment advisory services offered by Kalos Management Inc., an SEC registered investment adviser, both located at 11525 Park Wood Circle, Alpharetta, GA 30005 Kalos Capital Inc. and Kalos Management Inc. does not provide tax or legal advice. Skrobonja Financial Group LLC and Skrobonja Insurance Services LLC are not an affiliate or subsidiary of Kalos Capital Inc. or Kalos Management Inc.
Founder and Chairman, Skrobonja Financial Group LLC
Brian Skrobonja is an author, blogger, podcaster and speaker. He is the founder of the St. Louis-based wealth management firm Mo. Financial Group Skrobonja LLC. Her goal is to help her audience uncover the root of their beliefs about money and challenge them to think differently. Brian is the author of three books, and his Common Sense Podcast was named in the Top 10 by Forbes. In 2017, 2019, 2020, 2021 and 2022, Brian received the Best Wealth Manager award, in 2021 received the Best in business award and the Future 50 in 2018 from St. Louis Small Business.
Securities offered only by persons duly registered through Madison Avenue Securities, LLC. (MAS), Member FINRA & SIPC. Advisory services offered only by persons duly registered through AE Wealth Management (“AEWM”), a registered investment adviser. Skrobonja Financial Group, LLC, Skrobonja Insurance Services, LLC, AEWM and MAS are not affiliated entities. The article and opinions contained in this publication are for general information only and are not intended to provide specific advice or recommendations to any individual. We suggest that you consult your accountant, tax specialist or legal advisor regarding your personal situation.