You can’t pay off your debt until you do this first

If you’re trying to pay off debt without making sure that you’ve done all the necessary work first, you’ll never make any progress.

Debt looms large in our financial thoughts.

For example, in a list of 50 hashtags in the financial space, #DebtFree is on that list.

So clearly, debt, and getting rid of it, is on many of our minds.

It’s not hard to see why. Credit cards, mortgages, higher education, unemployment, a global pandemic, all leads us down the path to debt.

According to the New York Fed, via The Motley Fool, the average household debt in the U.S. is $146,000, and the median household debt is $67,000. (For Q3 2020.)

That’s a lot of debt.

So, naturally, there is a lot of focus on becoming debt free, or at least paying down your balances.

There are lots of ways to pay down debt. I favor the Debt Snowball method, though we can debate the methods.

I want you to pay down your debt. You can’t build wealth until you pay off debt, and I want you to build serious wealth.

But you need to do things in the proper order. You can’t climb Denali before you train for it, and you can’t swim the English Channel until you fill out your customs forms. #brexitjoke

And so before you can successfully pay down (or pay off) your debt, there’s one thing you need to do first.


Well first, what does actively paying off debt imply?

In the most simplest of cases, it involves taking excess funds, meaning funds not otherwise needed for other expenditures, and using it to reduce the balance of the debt.

Many debts can be paid off without using excess funds, paying just the mandatory minimum payments, but it takes a very long time, and you’ll pay a ton in extra interest. So we’re going to focus on making extra payments to pay down the debt faster.

So, a prerequisite for paying off debt is having excess funds.

Where do you get that excess funds?

You probably jumped to “make more money”, but you’d be mistaken.

Because there’s something even more basic that you need to do before making more money would even make a difference.

“Net zero”

Before you can pay off any debt, you need to make sure that your incoming money is at least equal to your expenditures. Your outgoing money, your Bills and Expenses, must be less than your Income.

In other words, you need to be “net-zero” for your budget, and on a regular basis, such as monthly.

This means that if you have a $4,000 income, you need to make sure that you are spending less than $4,000 a month.

You need to do this first. This is a prerequisite to paying off debt.

Why? Because if you don’t do this, you will never have reliable excess income. And you need reliable excess income to pay off debt, and not sit around waiting for a windfall.

Speaking of windfalls, why not try to just make more money? There is a limit to the amount you can save, but is no limit to the mount you can earn, isn’t that right Ramit?

I fully support you making more income. It could help, certainly. If you make $4,000 a month, and spend $6,000 a month, then making $2,000 more net will help you make up the difference.

But it’s not inherently what’s going to make your budget “net-zero”.

Alternately, you could spend $2,000 less in a month and not make more money. Or some combination.

It doesn’t matter. What matters is getting to the point where you spend as much as you make.

Digging out of a hole

If you don’t do this, and try to pay off debt before you get to this point, what’s going to happen?

Let’s say you want to aggressively pay down debt, and you make a plan to throw $1,000 a month at the debt.

But, let’s also say that at the same time, you’re spending $1,000 more than you make in a given month.

Where is that $1,000 going to come from? You guessed it: more debt!

So congrats, you paid off $1,000 in debt and took on $1,000 in debt to do it. Bravo. Slow clap.

So if you’re really fired up about paying off debt, and I hope you are, your next step may not be doing anything directly about the debt. It’s making sure that at the end of the month, you have some money left over.

After all, once you get to net-zero, anything beyond that is bonus. And that is how you pay off debt.

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