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3 Simple Steps To Becoming A Debt Free Millionaire
Step 1: Identifying & categorizing your debt!
We were brought up with this conventional wisdom that debt is bad or evil, and should be reduced or avoided at all cost. With our parents constantly preaching that it is smart to pay off your debt and to stay out of debt. You may not realize that this widespread idea of debt being evil is actually not true. However, only if we are well informed about the differences of debts, then will we be able to leverage debt to help us achieve financial freedom.
Debt can be categorized into two categories: good debt and bad debt. If you are currently buried under a mountain of debt, the idea that any kind of debt being "good" may sound crazy. But in actual fact, under the right circumstances and by managing your debts soundly, debt can very well have a positive impact on your finances.
So what makes a debt good or bad?
Good debt is debt used to acquire assets. Assets being something that’s going to put money in your pocket each month or appreciate in value over time.
Bad debt is consumer debt acquired by purchasing material possessions which depreciates in value as soon as they’re purchased.
In simple term, bad debt takes money out of your pocket, and good debt puts money into your pocket.
Listed below are examples of good debt & bad debt and its justification.
However, despite of being good or bad, debt is still debt. It is a commitment of yet-to-be-earned Ringgits to pay for past purchases. There is no guarantee that the good debt will end up being a good investment. You may end up getting poor grades in school and never land that six-figure job; you may never end up getting that promotion at work despite the certification; you may end up losing money on your home as many did in the 2008 financial crises or your small business may go under after six months.
Ultimately, debt is a financial tool. By itself, it is neither bad nor good. One must learn how to recognise its nature and utilise it to make sound financial decisions, driving us towards our financial goal.
Step 2: Eliminating your debts the FAST & RIGHT way!
Effective and efficient settlement of debt is the key to becoming debt free. In order to achieve this, you must first evaluate your personal financial situation and determine your financial starting point from which you can begin to navigate your course toward your financial goals. This can be done using a simple yet powerful Cash-FLOW Analysis.
Here is a template of the Cash-FLOW Analysis (CFA).
Cash-FLOWAnalysistemplate
The Cash-FLOW Index (CFI), an indicator of the health of your cash flow, can be calculated using the formula below:
So, what’s next?
Based on the condition of your CFI, you can apply certain debt elimination strategies to achieve ZERO debt as fast as possible.
Debt elimination strategies
1. The Snowball Principle
Step 1: List down your debts in the order of either smallest balance first or the highest interest rate first.
Step 2: Make minimum payments on all your debts except the prioritised debt.
Step 3: Pay as much as possible on your prioritised debt.
Step 4: Repeat step 2 & 3 until each debt is settled in full.
Why does it work?
What this principle does is that as the prioritised debts are eliminated, the payment for that debt is absorbed into your CFI and then applied to the next debt on the list.
As this continues, your CFI continues to grow just like a snowball does as it rolls downhill collecting more snow ie the health of your cash flow improves.
Who is this for?: Healthy & Adequate CFI
2. Trim down living expenses & create more positive cash flow.
Review your living expenses in your Cash-FLOW Analysis to see if you can reasonably reduce them to create more positive cash flow. You must be able to distinguish between financial needs and wants, thereby cutting down unnecessary expenses on our wants, in light of long term financial freedom.
Next, you should look for ways to create a second stream of income. Given the technological advancement we have today, there are tons of ways to earn extra income.
Methods to earn more money:
1) Driving Grab part time
2) Part time insurance agent
3) Start a drop shipping business
4) Start a Social Media Marketing agency
5) Part time financial advisors providing insurance, investment and finance related products and services.
6) Freelancing: selling your skills on platforms like Fiverr and Facebook
7) Affiliate marketing
8) E-commerce
Both of these would translate to a higher CFI, allowing you to make use of the snowball principle to eliminate debt and increase cash flow.
3. Home equity loan / Refinancing
A home equity loan is a financial product that allows a homeowner to borrow against the equity in his or her home, ie a second mortgage.
When all reasonable and realistic attempts to improve your cash flow are still not enough to improve your CFI, and you have a home with equity, then taking out a home equity loan can be a good way to tip the scales towards more positive cash flow, and as a result improve your CFI and eliminating debt.
Is this a good idea?
Secured debt ie Home equity loans have lower interest rates than unsecured debt, such as credit card debt. This can help you save on interest payments and improve monthly cash flow if you need to lower high-interest debt.
However, there are always two sides of a coin:
• Risk of losing your home. Home equity debt is secured by your home, so if you fail to make payments, your lender can foreclose on it. If housing values plummet, you could wind up underwater, meaning you owe more on your home than it is worth. Your credit and finances could take a major hit, too.
• Hidden borrowing costs. Some lenders charge fees for home equity loans. As you shop lenders, pay attention to the annual percentage rate (APR), which includes the interest rate plus other loan fees, e.g. stamp duties, lawyer fees, disbursement fees and processing fees. If you roll these fees into your loan, you’ll likely pay a higher interest rate.
Hence, it is a strategy that should be utilised cautiously.
Who is this for? : Poor & Adequate CFI
4. Credit Counselling / Debt Management Programme
What is credit counselling / debt management?
This is when you engage a third party to help negotiate with a bank to deal with your debts.
In Malaysia, we are fortunate to be able to turn to the services of a credit counselling agency managed by Bank Negara Malaysia, the Credit Counselling and Debt Management Agency (AKPK).
Run by Bank Negara Malaysia, AKPK operates as a non-profit and does not charge for its debt counselling service.
Does seeking help affect your credit score?
By large, seeking the help of AKPK will not have a negative impact on your credit score. However, it will appear as a note from the Central Credit Reference Information System (CCRIS); letting financial institutions know of your current status.
This would mean that you stand a high chance of being denied approval for new loans or credit cards; regardless of what your actual credit score is.
However, sticking to the plan will eventually raise your credit score. This is because your payment history has the most weight in calculating your score, and you should be making consistent payments over the course of AKPK’s programme.
Alternative?
Aside from AKPK, another sound option is to seek a Certified Financial Planner (CFP) whom will help you create a comprehensive financial plan for managing your money.
CFPs specific knowledge and expertise on areas, e.g. insurance planning, investment planning, income tax planning, estate planning and the maximisation of retirement benefits program, would ensure that you’re making the best out of your current financial situation.
Given that,
Seeking a CFP does come with a cost. Typically, CFPs would either charge a professional fee or provide their services for free and earn a commission from companies who offer the financial products.
CFP Board’s code of ethics requirement ensures that they act as fiduciaries, ie always making decisions and recommendations that are in their client’s best interests, and not their own. As such, despite being commission based, the concern that CFPs would only steer clients towards products that yields them a higher commission should not be a big concern.
Howbeit, there’s a black sheep in every flock. Hence, the choosing of a financial planner should be done cautiously based on referrals, licensed by securities commission, qualification, experience, trustworthiness, background check, on-going services and written agreement.
Who is this for? : Poor & Adequate & Healthy CFI
Step 3: Becoming a MILLIONAIRE
Now that you have become completely debt free, the reality of becoming a millionaire is right around the corner, that is, if it is done correctly.
The very first step to becoming a millionaire is Financial Planning. Proper financial planning takes into account the whole picture and not just a piece. Increasing wealth and becoming a millionaire might be your current goal, but if you don’t have a plan for emergencies, that goal can get derailed in a second and kill any dreams of sipping margaritas on the beach.
Hence, the Financial Planning Pyramid:
