Hosted By: Wyatt Yates
Money Myth: Pay Your Highest Interest Rate Debts First
In this episode, we discuss the best way to get out of debt. Why you need to take into account human behavior and emotion when tackling the goal of getting out of debt. Does this money myth work? Is it the method I used to pay off $300K in debt? Listen to find out.
1) If you have consumer debt, use the Debt Snowball Method to get out of debt. First, make a list of all your debts from smallest to largest balance. Then start tackling paying off your debt following the Debt Snowball method.
2) Look at your monthly budget...where can you make sacrifices to allocate even more money to your debt snowball payments? Start small, make a 1%-5% cut and then increase it each month.
Wyatt Yates Host 00:00 Money doesn't have to be complicated. You can achieve financial independence. This podcast gets to the truth behind the money mess you hear from your grandma, your broke uncle, the latest social media influencers and the so-called money experts. Welcome to Money Myths with your host, wyatt Yates. This week's myth is pay your highest interest rate debts first when you're trying to get out of debt. 00:31 Now to start this one off, I just wanted to first go through some of the stats behind consumer debt in the US and give you a broad picture of what it looks like. So a lot of these stats are coming from Experian. Actually, I think all of them are from Experian, which is a credit reporting agency. There's three agencies that give you your credit report, your credit score, so they have all the data behind consumer debt in the United States. So the total consumer debt in the United States is right now at an all-time high at nearly $15 trillion. To give you a little break out of the makeup of what this debt consists of, I'm just going to go through the major categories here. So home mortgages makes up the bulk of this, at $10.3 trillion, but that still leaves us with nearly $5 trillion of other consumer debt. Student loans is now at an all-time high at $1.6 trillion, with the average balance for consumer loans that a person holds at just under $39,000. At $38,800 is the average balance for student loans. Auto loans is next at $1.4 trillion, with an average balance of just under $20,000 at $19,700. Credit cards make up $836 billion, with a person having an average balance of $5,300. Then home equity loans in lines of credit make up $494 billion, with the average balance being $42,000. Personal loans is the last major category, at $324 billion, with the average balance at $16,500. We're at all-time high in consumer debt. So this is a big issue for a lot of people. Knowing how to best tackle it is what we're going to go through here. 02:38 What this myth looks at is pay your highest interest rates debts first. Does that work? Is it the best method there is? This is a big problem for a lot of people. One of the things a lot of my clients will say or use as an excuse is the fact that housing costs are going up and the cost of living is going up. That is why they have to go into debt to be able to maintain their lifestyle. Because of all the increased costs, whether it be on healthcare or housing or any other category. They have the excuse of that. My costs are going up and that is why maybe we have to go into debt, or you'll even hear a lot of financial experts or economists or different people talk about that it's harder to get by with. The wages are where wages are with the increased cost of living, but this simply is not the case. 03:36 So let's look at experience, stats excluding mortgages, looking at consumer debt excluding mortgages and the change that people had in consumer debt from 2019 to 2020, and look at specifically states, because we can associate states with different states with higher costs of living. So, looking at the stat, the five states with the largest percentage increases in consumer debt from 2019 to 2020 were first North Carolina, second Idaho, third Nevada, fourth Kentucky and fifth Oklahoma. So North Carolina came in with an average increase of almost 6%, whereas Oklahoma was at 3.5% increase in consumer debt from 2019 to 2020. Oklahoma, Kentucky, even Idaho not states you associate with really high costs of living. Now the five states that had the lowest cost of living changes actually had decreases. These five states were first Connecticut with a 3% decrease in consumer debt, then Hawaii with a 2.9, then New York with 2.5%, then New Jersey at 2.2% decrease, and then fifth came in Maryland at a 2% decrease. And California was actually number seven as far as a decrease in consumer debt from 2019 to 2020 of 1.6%, and Illinois, washington DC and Alaska all had decreases in average consumer debt. So a lot of these states associated with higher costs of living actually had decreases in the years 2019 to 2020. 05:23 This isn't a cost of living problem. It's a behavior and education problem. The 27 largest banks and credit card companies spent over $13 billion in advertising in 2018, which was a 7% increase year over year from 2017. And the Consumer Financial Protection Bureau, the CFPB report from 2013 found that $17 billion was spent on marketing financial products, while only $670 million was spent on actual financial education. We are constantly bombarded with credit card companies or banks offering credit cards or auto loans or home equity lines of credit. The amount of money these institutions are spending advertising this and marketing these products to us is crazy, but they continue to do it because they're getting a return on their investment. We are falling for it when they keep pushing more money to advertising and just constantly bombard us, whether it be online, on the radio, anywhere you look, there's advertisements for this, for you to take on more debt, and it is working. They're continue to reach all time highs year after year, almost in consumer debt, and the financial institutions are making big profits from it. 06:54 The average person in the US is literally drowning in debt and it's robbing them of their future income. It is restricting what they can and can't do. Have a job you hate. Can't leave because you need the income to be able to pay your creditors. Wanna start your own company? You can't do it because you need a steady income to be able to pay your creditors. Debt robs you of your future income. It takes it away and is assigning a place for it that it has to go. So when you have debt, you are limiting your future income and what you can do with it. 07:28 So let's look at this myth and why it's true. Now. The myth is pay your highest interest rate debts first. Mathematically, this makes sense and is the correct thing to do. It will minimize the amount of interest you will pay and, as a result, you will pay less to pay off all your debts. But why is it false? First of all, you suck at math. If you were good at doing math, and what makes the most mathematical sense you wouldn't be into debt in the first place, because the math would tell you if I have to go into debt to buy it, I don't have enough money to afford it. Math would tell you paying interest to someone else is worse than earning interest for yourself. So you suck at math. When you're in debt, it's okay. We've all been there, I've done it myself. But that is one reason why the method that makes most mathematical sense to get out of debt doesn't work for most people, because the simple fact that you're in debt means you're not doing the math correctly anyway or you can't follow what makes sense mathematically. Another reason why number two is it doesn't take an account human behavior in emotion, which is what the majority of personal finance is. We know what we're supposed to do but we don't do it and this method Doesn't take that into account. And the third reason why this method doesn't work for most people kind of piggybacks off of the whole human behavior and emotion side. 09:04 This method takes Discipline and commitment to pull off and the majority of people are not disciplined and committed, especially when they don't see instant results. Example two-thirds of the US population is either overweight or obese. Across the world there are now more overweight and obese people than people facing starvation. It's a major accomplishment in terms of world hunger, but every one of these people that are overweight and obese knows that all they have to do is eat healthier and just do minimal exercise and they will lose weight and be healthier. Yet they don't do it because it takes discipline and commitment to do and you don't get instant results. That's why the weight loss industry in the United States is a 78 billion dollar industry. People want the easy way. They want instant results. They're not disciplined or committed, and that is why this method doesn't work, because you're not seeing instant results with it. 10:08 So I'm just gonna summarize what we went through and then look at a method that actually works. So we know the average American is drowning in debt and most of the metrics are only getting worse. They are struggling to figure out how to pay off their debts. They're struggling to even make minimum payments, and this money myth of paying your highest interest rates first Only works in theory for the most part and for the most disciplined people, which, if you were disciplined, you wouldn't be into debt in the first place. You would understand. If I have to go into debt, that means I can't afford it and it's gonna rob me of my future income. So is there a method that actually takes into account human behavior and this whole need for instant gratification that the majority of people have? And Luckily there is, and it's the same method my wife and I used when we paid off over $300,000 in debt in a couple years. It is called the debt snowball method. The debt snowball method has helped more People get out of debt than any other method so far six million people in counting. 11:16 It is simple and concept and it gives you the instant Gratification you need to stay the course and paying off all your debts. It does no good to start paying them off and fall off the wagon, and this helps you stay on track. This method does so. Here's how it works. First, you list all of your debts, from your smallest balance to your largest balance. Now, it's not by category, it is simply your actual debts. So you may have student loan debt, but you may have five student loans you're paying on. Or you may have credit card debt, but you may have Four credit cards that you're paying on. You're gonna list each one of those individual student loans or credit cards Basically, any payments you're having to make towards your debts is one debt and you're gonna list those debts from smallest balance to largest balance. Now, the one thing you will exclude from this list will be your mortgage payment. If you have a Home equity line or maybe a second mortgage, depending on the balance, you may include it in this list For your debt snowball, but typically your mortgage it will be excluded from the list. This list it's gonna be Basically student loan debt, any medical debt, personal loans, credit cards, any auto loans, anything like that. 12:37 Then each month you're gonna pay the minimum required payments on all your debts except your debt that has the smallest balance, and you're gonna throw all your extra money that month into paying the extra on the smallest balance first and you keep on doing that until that smallest balance is paid in full and then you cross that debt off. It's gone. It's gone forever. And you do the same concept with your next smallest balance. So you're gonna make the minimum payments on all your debts and then now your smallest balance that you have which would have been your second smallest balance initially gets all your extra money and you keep doing this month after month until all of your debts are paid off, and you're gonna keep on making only minimum payments on your debts, all your debts except the smallest one, and that's the one you put all your extra money to. Now just a quick tip, like if you're just starting out budgeting what I have a lot of my clients do, because those first couple months with budgeting can be a little hard as far as getting it really nailed down. So I tell them pay all your debts, the minimum payments on all your debts, and then, when you get to the end of the month, make a second payment on that smallest debt. And that helps you get through the first couple months until you really nailed down your budget and making sure that you're gonna have money left over to pay those extra payments. 14:04 So the concept of the debt snowball is minimum payments on all your debts, doesn't matter what interest rate it is. We're looking at a method that really looks at human behavior and emotion and getting instant results. So you're listing all your debts, from smallest to largest, paying minimum payments on all your debts except the one debt that is currently your smallest balance, and you throw all your extra money at it and you work your way through. And what this method does it gives you that gratification of paying off a debt in full, where, when you're doing the interest highest interest rate first method, you may not get that instant gratification of paying off a debt right out of the gate because your highest interest rate debt may be your largest balance, but a lot of my clients and ourselves included when we went through our thing you typically have some smaller debts that you may even be able to pay off and follow that first month or the first couple months, and that gives you the momentum you need to increase your motivation to follow through, because you're seeing that instant result and it just reinforces the behavior of attacking your debt and getting out of it. 15:14 So for the action steps this week, the first action step is if you have any debt, I want you to use the debt snowball method to get out of debt. So the first step you're gonna have to do is list all your debts, from smallest balance to largest balance, and in that list include what the minimum payment is for each debt and you're gonna incorporate that into your monthly budget and you're just gonna do minimum payments on everything except your smallest balance debt and then you're gonna throw all the extra money you have from your budget into paying extra on that smallest debt. So first action step is, if you have debt, use the debt snowball method to get out of it and first make your list. The second action step is to look at your monthly budget and see where you can make sacrifices on expenses to have more money to allocate towards your debt snowball. 16:10 Now I always tell my clients you can't reach a goal without making a sacrifice, and to get out of debt there's two sacrifices you can make now. You can just make one of them or you can make both of them. The more sacrifices you make, the faster you it will work in, the faster you will reach your goal. But the two things you can sacrifice when getting out of debt or with any financial goal really is first time. Second things. So time is used to increase your income. So that may mean you have to work more to be able to figure out how to get more money coming in to increase your top line income Now with things, that is your expense side. So sacrificing that vacation or things, or selling things that you can get more money from, things that are laying around the house that you don't use anymore. So those are the two sacrifices you have to make to reach any financial goal, either time or things. 17:09 Now for this second action step on where you can make sacrifices to allocate more towards your debt snowball. Just start small, maybe make a 1% cut somewhere and then increase it each month. Or I wouldn't go over a couple percent or a 5% cut in any one area because this is a habit change. So you're gonna make small improvements each month to make those cuts. So, right out of the gate, just go through your major categories in your budget and just try to cut each category or each line item in your budget by 1% or 2% and then just increase it each month. And then you're gonna take that extra money you're getting from your savings on cutting expense items in your budget and you're gonna allocate that all to throw at your debt. And as you make progress through the debt snowball and start seeing that reinforcement of instant gratification with paying off those smaller debts, it's gonna build momentum and you're gonna get more motivated to make bigger cuts in either time or things to speed up the process and get out of it. So that is the method I recommend. It's the method I used. 18:22 Follow those couple action steps and start your journey to getting out of debt. It won't be easy, but anything worth accomplishing is never easy and it will be totally worth all the hard work that it takes. Once you finally pay off that last debt, trust me, you'll have a sense of relief. You're no longer carrying that burden of having to pay off. Pay all your money towards all these other people. You'll be able to keep more of your money, you'll be able to invest, you'll be able to reach financial independence and your future income is no longer being stolen from you and taken by creditors. 19:03 Want to achieve financial independence? Go to ruggedfinancialcom, where you can download my free PDF of the 12 Things to Do to Win With Money, and you can also sign up for my weekly money tips emails, where I cover the same tips and tricks and advice I walk all my clients through so you can begin your journey to financial independence. Thank you for watching and listening to this episode of the Money Myths Podcast. 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