Posted on | January 23, 2017 | Comments Off on Managing Debt for the Sake of Cash Flow and Investing
Debt is a dirty word to many people. It requires that you pay money for the privilege of using other people’s money. It can tie up much of the income that a person earns. This income could better be used on his needs and his wants. Finance gurus like Dave Ramsey give some great plans regarding how to manage debt. Ramsey and others like the popular personal finance blogger Mr. Money Mustache rightfully claim that debt is actually an emergency akin to “a cloud of killer bees covering every square inch of (his) body.”
Debt Is Problematic
Debt can definitely become a problem when you have too much of it. More and more of your paycheck can go toward paying interest on money that you’ve borrowed. When the debt load becomes too high to handle, people can lose access to credit, and bankruptcy can become a definite possibility. There can be decent uses of debt like buying a home or getting an education that allows you to make more money in the long run. However, most other debt can be a real drain. Here are two major reasons to manage your debt.
- Debt Hurts Cash Flow
It’s very important to understand cash flow. Income is the money that comes into your pocket. An expense is money that leaves it. If your income exceeds your expenses every single month, this means that you have a positive cash flow. When a family finds itself with a positive cash flow, they have the ability to build up an emergency fund that can alleviate the need for taking on debt to take care of extraordinary expenses.
With no cash flow for building up a savings account, it can quickly become a really big problem when a tire goes flat or a roof needs replaced. These expenses can be even bigger problems without access to credit. A bit of a cushion between income and expenses every month can lead to a greater peace of mind and a more comfortable home life.
- Low Debt Allows For Investment
Lower debt payments are positive. The lower a person’s debt, the more positive her cash flow is likely to be. After building up an emergency fund, the excess cash flow can then go to investments. When it comes to investing, individuals and families can really start to build up wealth. Bonds and dividend stocks can pay interest or dividends that can add to the positive cash flow.
When you’re in debt, compounding interest works against you. A family who takes out a standard 30-year home mortgage of $100,000 at 5 percent interest will pay the bank nearly $5,000 the first year of the loan. A hypothetical borrower one this loan would only pay $120 back on the loan the first month. On the other hand, nearly $417 would go to the bank. That $417 is money that is gone forever and does nothing to improve one’s overall financial situation.
When you’re investing, compound interest works for you. The excess capital that you can put to work on a monthly basis adds to your net worth. It also improves the overall cash flow for your family. Each dividend or bond interest payment that you receive is actual cash that you can use either to buy more stocks and bonds or to pay monthly expenses like housing, gas, groceries or utilities. The snowball of cash flow and wealth is growing in your favor, rather than in the favor of the bank as is the case with debt.
Manage Debt To Build Wealth Over Time
Managing debt is one of the most important steps that an individual or a family can take toward building up a positive financial situation. Excessive debt can hamper the ability to build wealth over the long term. Those with low debt and positive cash flows can see their wealth and income grow over time through smart investing, and the time to start on this process is now.