For years people have been telling you that you can pay off your debt – just spend less than you earn.
But here is the thing: paying off your debt is not always as easy as cutting out some ‘fat’ from your budget. It is a bitter truth to process and accepts, but sometimes you are in a bind, and you just cannot pay off your debt without making significant changes to your life.
‘Okay, Maria, I understand that – you may think. ‘But how do I know whether I can pay off my debt or I am just going through pointless moves leading to a highway to nowhere.’
Thank you, friend, for asking the sixty-four thousand pounds question.
I am not going to lie to you: figuring this out is not easy. When we were in so much debt that I saw only darkness in my future, I felt unsure. Then I worked it out using a simple calculation – I call it the Debt Payment Coefficient or DPC (after all, I don’t wish to spook you with maths, right).
Can you pay off your debt? How do you calculate your debt payment coefficient (DPC)?
To work out your (DPC), you must know your:
- annual pay after-tax (this is what reaches your bank account after all taxes and deductions);
- total amount of consumer debt (this is how to work out your total consumer debt); and
- annual survival budget.
The formula for calculating your DPC is
(Annual Pay After-Tax – Annual Survival Budget)/total debt
What is your DPC?
Just a reminder that:
- A DPC higher than 0.18 means that you can confidently pay off your debt.
- A DPC lower than 0.18 means that paying off your debt will be a stretch.
Please remember that having a DPC below 0.18 does not necessarily mean you should be looking at other options; it may merely mean that you must get more creative with your debt payment strategy.
A note on working out your survival budget
What is a ‘survival’ budget?
It is the absolute minimum on which you can survive. Your ‘survival’ budget is not one that will afford you the lifestyle to which you aspire or even the one you are accustomed to. Still, you can survive on it for several months without feeling the pinch. We lived on a ‘survival’ budget for approximately seven months.
Here is how to estimate your ‘survival’ budget using what you already know about your fixed, changeable, and variable spending. It works best if you use The Money Principle Monthly Budget Planner.
Now that you have all the information you need, you must:
- Ignore your fixed spending for the moment because you cannot change it in the medium term.
- Question your changeable spending and think of ways to reduce it. You could change your insurance, for example, or replace your car with a cheaper one to pay off the car loan.
- Slash your variable spending by getting rid of everything non-essential like new clothes, holidays, paying for services, keeping dependants, un-used subscriptions, etc.
Hey, presto! You have your survival budget at your fingertips.
(It is wise to allow for some frivolity in your survival budget – it is not realistic to live on bread and water over several months, or even years.)
Expect your ‘survival’ budget to be between twenty and fifty per cent lower than your ‘normal’ budget burn.
What to do if you cannot pay off your debt?
What is your DPC, again?
Is it over 0.18? Relax and set your monthly debt payment amount – you have this. And you may decide to speed up the debt payment by increasing your income without allowing lifestyle inflation to creep into your budget.
If your DPC is below 0.18, though, you have a problem – not enough money to start paying off your debt.
Once you know that you cannot pay off your debt from your present situation, you have a choice:
- You can either accept it and look for another option (bankruptcy, IVA, DRO, or other); or
- You can take another look and start figuring out how to change your situation.
Acceptance comes at a price, and you can read more about it here.
If you decide to explore how to change your situation, please consider:
- Ways to increase your income; and
- Ways to reduce your total debt fast (sell something, for instance).
- Have another look at optimising your spending (but do it smart because cutting completely down is not sustainable even in the short run).
Can you pay off your debt? Final thoughts
Can you pay off your debt?
Take the guesswork out of it and work out your DPC.
Yes, I know that many decisions must be made, but you can do it – you need knowledge, ingenuity, and debt-paying lust.
What are you waiting for?