5. Automating Your Debt Away

5. Automating Your Debt Away

"What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience?” — Adam Smith

Your debt is the chain keeping you from reaching the surface of a wealthy life. With it weighing you down, it is extremely difficult to become a millionaire. To fix that, let's set up your finances so that you eliminate your debt automatically.

Step 7: Figuring out which debt to pay off first

Let's say that John is currently $36,000 in debt, but $24,000 is from his mortgage. The rest of his debt ($12,000) comes from a student loan he got for his education.

As John looks at his debt-paydown page, he notices that the APR for his mortgage is 4%, and his student loan is 3.2%.

This raises a good question: Should John start paying off his mortgage or student loan first? The answer is simple: He needs to pay off his loan first because it has a higher APR than his mortgage.

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Annual Percentage Rate (APR) is "the annual rate of interest charged to borrowers and paid to investors" [1].

A higher APR means that John's student loan debt will increase exponentially (very fast). Currently, the APR for this student loan is 4%, meaning that his debt will quickly grow every year if he does not pay for it.

In contrast, his mortgage's APR is only 3.2%, meaning that his mortgage debt will grow 0.8% slower than his student loan debt.

Like John, you must determine which loan you have the highest APR. If you'd like to see the average APR on the most common loans as of @September 4, 2020, here they are in descending order:

  1. Credit card APR:
    • Average credit card APR [1]: ~13%
  2. Personal loans:
    • Average 24-month personal loan APR [1]: ~10.5%
  3. Education Loan:
    • Average student loan APR [1]: ~5.8%
  4. Home equity loan averages:
    • 10-year fixed home equity loan [1]: ~5.74%
    • 15-year fixed home equity loan [1]: ~5.74%
    • HELOC [1]: ~4.8%
  5. Auto loans:
    • Average 48-month APR [1]: ~5%
    • Average 60-month APR [1]: ~4.5%
  6. Mortgages:
    • Average 30-year APR [1]: ~3%
    • Average 5/1 APR [1]: ~3%
    • Average 15-year APR [1]: ~2.5%

Looking at the list above, it's clear that credit card debt is the one you'll want to get rid of first. If you don't have credit card debt, you'll want to start with any personal loans. If you don't have any personal loan debt, you'll want to start with your education loan.

As an aside, it is possible to have "good" debt. To keep this guide short, we won't cover it here. But if you're interested in learning more, click here. But, in most cases, debt should be avoided at all costs.

Step 8: Setting up your debt timeline

Now that John knows he needs to pay off his student loan debt first, he decided to pay all $12,000 of his total debt in four years. That means he needs to save about $3000 yearly to pay back the loan completely.

If your highest APR loan is bigger than John's, consider extending your timeline from four years to five, eight, or even more years. But remember, the longer you take to pay back your loans, the more you will have to pay back overall.

He—and you—need to start setting aside 1/12 of your chosen yearly amount every month. For John, that means he must put aside about $250 monthly. To make sure that he has enough, he checks his average monthly income from his 1-Year average monthly income from the 3. New Age Budgeting3. New Age Budgeting page:

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Since he earns just over $1544 monthly, he has enough cash to save $250 monthly to repay his student loan. You must also ensure your income is large enough to support your monthly debt payment!

Step 9: Automate your debt-free life

To ensure that he saves $250 every month, John set up an automatic transfer of $250 on the first day of each month (the day he gets paid) from his checking account (where his paychecks go) to his student loan debt issuer.

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How you set up your automatic money transfers will depend on what bank you use and who your debt holder is. For a great, in-depth article on how to set up automatic payments, click this link.

At this point, John is automatically moving $250 from his checking account to his debt holder and will be student debt-free in about four years.

While he has automatic payments for his student loan, he also sets up the minimum automatic payment to his mortgage! He only pays the minimum because he knows that once he finishes with his highest APR debt (a 4% student loan), he can then switch to automatically paying his mortgage at the full amount he is able to cover.

If you have any questions about the abovementioned process, click here to send them.

Optional Step: Automate your credit card payments

This is for those of you who want to automate all of your finances. By automatically paying your credit card bill every month, you ensure that you will never again go into debt—well, at least as long as you have enough to pay it off, of course.

To save reading time for those who don't care about completely automating their finances, check out nerdwallets automatic credit card payments article if you're interested in learning more. Once you're done setting that up, return to this page to continue reading.

Closing thoughts

Remember, high APR debt is the number one reason that poor people do not become wealthy. Debt will not allow you to compound your money, and as we have already covered, compounding your money is the secret sauce to becoming wealthy.

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We feel for those of you who are tired of reading and/or looking at numbers. Worry not—you have now completed over half of the guide! Remember that you can get the "cheat sheet" for this guide by clicking here.
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