July 17, 2013, 7:16 am

How to Pay Off Debts Efficiently – Here’s My Plan

by: The Financial Blogger    Category: Pay off your Debts
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With my wife starting her daycare at home in September, there will be additional income coming in. I have the habit of reviewing my personal finance on this blog and thought I would share a few plans to pay off my debts in order to help you to do the same thing.

 

I usually manage my budget in a very uncommon way since I have been making important year-end bonuses over the past five years (read the chronology of my income here). This allowed my wife to stay at home while raising our three children but it has also given me a few headaches while managing a monthly budget deficit compensated by a lump sum payment in January. I’ve enjoyed life too much in the past three years with major expenses such as:

 

  • A sports car (my expensive maintenance RX-8) – $12,000 + $5,000 in repairs over the past four years
  • A trip to Disney World and another one at Virginia Beach – totaling almost $9,000
  • A brand new pool – $10,000
  • A central A/C – $8,000

 

With a single household income and additional expenses, you can guess that my total debts didn’t drop during that period. Surprisingly, I’m not doing as bad as my debts level is actually lower than it was when I first reported my net worth back in 2011. But now that we will be making more money, it’s time to establish a strong plan to get rid of debts. I’ve ran through different scenarios to see what my options are.

 

Listing my Consumer Debts

 

The first thing I need to do is to make a list of debts to pay off along with their current monthly payments. I’ve made a quick chart to have a good picture.

 

DebtsAmountMonthly PaymentInterest Rate
CREDIT CARD$5 781N/A19.99%
LINE OF CREDIT$19 592$1001.50%
HELOC$264 384N/A1.50%
CAR LOAN$9 982$4340.90%
Personal Loan$7 083$2303%
Pool Loan$5 173$706.45%
.

I didn’t put payments for my credit card and home equity line of credit (HELOC) since I play around the balance of both to never pay high interest rates on my credit card. I’m usually able to drop the HELOC balance with my year-end bonus but it goes back up during the year due to my monthly budget deficit. Thanks to the daycare, I won’t be seeing a deficit anymore!

 

Option #1 Sell My RX-8

 

Since my wife will be working at home during office hours, she won’t need a car anymore. I could sell my sport car and use the family SUV to go to work. If I sell my RX-8 this year, I should get something between $5,000 and $6,000. This is enough to pay off my credit card in full and concentrate on other debts. I usually play around between my home line of credit and credit card to not pay high interest. By selling my car, I wouldn’t have to play around anymore and I could use my liquidity to pay another debt. I would not only get at least 5K in my pocket but I would also save about $300 per month worth of gas and insurance costs (without counting maintenance!). I don’t really want to sell my car because I love it, but I think I would like to pay off my debts more at this point in my life!

 

Option #2 Using Daycare Revenues to Make Extra Payments

 

My Tribute car loan expires in 2015 with 23 payments left as of July. This is not my biggest interest rate debt (this is the pool loan) but this is my biggest monthly payment. The daycare should generate roughly $2,000 per month in free cash flow. Considering that I have to use a part of this money to cover for my monthly deficit, I estimated my free cash flow at $976 per month. In September, the car loan will be showing a balance of $9,114 (2 payments done in July and August). Starting in September, I could make a total payment of $1,410 (which is $434 from my regular payment + $976 in extra income). At this pace, my car loan will be finished within 7 months which leads us to end of March 2013.  At this point, I will be able to use my extra $1,410 to start a debt snowball and pay off another debt.

 

In March 2013, my personal loan balance should be around $5,211. Using the current monthly payment of $230 plus the $1,410, I could make payments of $1,640. In three payments, I could almost pay this debt off as well. This leads us to end of June 2014 to attack the pool loan. At this point, the pool loan should total roughly $4,600. With a monthly payment of $1,710 ($1,640 plus regular monthly payment of $70), I can clear it in three months as well. Therefore, in September 2014, I could show only my home equity line of credit along with my line of credit balance for a total debt of $284,000 or lower. With an additional payment of $1,710 per month, paying off my line of credit will be a piece of cake taking about a year to clear it up.

 

Option #3 Paying Off My Line of Credit ASAP

 

In order to make my life easier in terms of budget management, I think I will opt for option #3: paying off my line of credit ASAP. By increasing my monthly payment to $1,100 on my line of credit I will be able to drop its balance rapidly. Once I pay enough on the line of credit to clear another debt (e.g. my Tribute car loan), I will draw a check from my line of credit and pay it off. Then, I will increase my monthly payment on my line of credit and repeat the same process to attack my personal loan.

 

It will be much easier than playing around with my bank to increase payments. Plus, if I ever run into unexpected expenses (we all know it never happens, right? Hahaha!), I will have the liquidity on my line of credit instead of getting stuck with a huge monthly debt payment on a loan.

 

What’s Next?

 

According to this plan, I could be left with only my home line of credit to pay in 2016. At this point, I will most likely start saving $1,000 per month to invest and use the extra $710 to pay off my debts. However, I know there are other expenses that will come around that time too… My Tribute will probably due to being changed by 2019 (it’s a 2009) and I really would like to have a garage and finish my basement so my kids could have their own space. Therefore, I will most likely save $1,000 per month in investments and use the $710 monthly to build an emergency fund that will be used to pay for a new car and then pay for renovations. Private school will also arrive just around the corner so I better be ready for this (and increase my monthly savings in my TFSA to fund it!). The good side of things is that my income will most likely become bigger and I will be able to fund these projects with my year-end bonus.

 

Readers, have you ever done a plan like this? What do you think of mine?

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Comments

by: OttawaGuy | July 17th, 2013 (9:06 am)

TFB,

Have you considered selling some of your portfolio to pay this down? (Or does that sounds as odd to you as debt repayment? lol) I’m not sure what your average return is but it might be worth at least selling $10K to kill a balance or two.

Is your HELOC invested? I hope so as the interest rate is amazing.

by: The Financial Blogger | July 17th, 2013 (9:28 am)

Hey OttawaGuy,

All my investments are in RRSP’s so I can’t cash them without paying a huge chunk in taxes… I’ve made a priority of contributing to my RRSP (as well as my RESP and TFSA) instead of paying debts as I want to make sure I save money aside for my retirement and my children education. They are more important than my consumer debts ;-)

I use my employer stock once or twice a year to pay down my debts already so I can’t really do much with that right now.

I plan on investing with my HELOC (e.g. Smith Manoeuvre) once I’m back with a positive monthly budget. Right now, I often need to take money from the HELOC to support my lifestyle until I receive my year-end bonus.

Why are you more interested in paying down your SUV loan (at 0.90%) than your pool loan (at 6.45%) or personal loan (at 3.0%)? Based on the information you gave, I would:

1. Sell the RX-8. Use the proceeds to pay off the pool loan immediately.

2. Use the additional money (including the $300+/mo from the gas/insurance/maintenance savings) to pay off the 3% personal loan.

3. Start paying down the line of credit with the additional money as your “emergency fund.” Rather than have cash on hand (most likely earning <1% interest), you will still have easy access to the LOC and be saving 1.5% in the meantime.

This is all assuming you are not paying that credit card interest rate and indeed you somehow "play around the balance of both to never pay high interest rates on my credit card."

Also, you said: "Once I pay enough on the line of credit to clear another debt (e.g. my Tribute car loan), I will draw a check from my line of credit and pay it off."

I'm not sure I'm reading that correctly. Do you mean you would pay off your car loan with your line of credit? If so, why would you pay off a 0.90% loan with a 1.50% loan? That doesn't make sense.

by: The Financial Blogger | July 17th, 2013 (1:49 pm)

Hey Travis,

I thought of going with the higher interest rate at first in order to save on interest. Then, I’ve realized that my highest interest loan (the pool loan) is also the smallest payment in my budget (due to the ridiculous 10 year amortization).

I rather focus on increasing my cash flow (so starting with the Tribute loan which take $434/month out of my monthly budget) then saving on my interest rate. However, I didn’t do the calculation of how much I pay in interest if I focus on the cash flow vs interest rate.

Thx for the additional thoughts, I’ll do the math to see which one is best. Maybe I should start to take my first 5 months of free cash flow and pay off the pool loan instead. The debt snowball will be a lot smaller (adding $70 instead of $434) but I will probably pay less interest that way…

Definitely run the numbers to compare cash flow vs. interest rate so you can see the overall costs both ways. My guess is it will be at least a few hundred dollars in savings by the time you have the car loan, personal loan, and pool loan paid off if you focus on the higher rates first.

Also, something else I just thought about. I’m sure you already know the details of your loans, but just make sure you don’t have any prepayment penalties. I helped out one of my employees a couple years ago with some loan consolidations and her car loan had a prepayment penalty. It was still better to do the consolidation since her original rate was pretty high and it wasn’t much of a penalty, but it’s something to keep in mind, especially when you have such a low rate.

If your car payment wasn’t so high — which, like you, I would want to get rid of quickly simply so it wasn’t hanging over my head — I’d say to not even worry about paying that loan off early. It would be better to start investing earlier and keep paying the 0.90%. The same argument could possibly be made for the 3% loan. For the 6.45% loan though, regardless of the monthly payment amount, it’s a good savings to pay that loan early. Figure that’s like getting a guaranteed 6.45% bond return. Not too shabby.

Regardless of which way you pick, I commend you for knocking out some of your debt. There is really no “best” way to do it. Sure there is a best way as far as the math goes, but the emotional stress factor caused by loans/payments depends on the individual. The best way is really whichever is the most comfortable way for you.

Did I sense the reluctant to let go of your RX-8? :-P

by: The Financial Blogger | July 19th, 2013 (5:51 am)

Oh Bernard, you are sooooo right ;-) hahaha!

I would pay off credit card (transfer the balance) and pool loan. The others have interests that are lower than inflation! Why would you pay those off at all???

Hey Derek,

I’ve thought like this for a while and concentrated on building wealth. But after a while, I wasn’t using my money to build wealth anymore, I was using it to buy more stuff and enjoy a bigger lifestyle. This is why I want to cut down my expenses even thought the interest is below the inflation. I want to reach financial freedom and I won’t make it happen without clearing those monthly payments!

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