You want to get out of debt so you can reduce your risk, increase your cash flow, and have greater peace of mind, right? As an efficiency expert for dentists, I deal with this issue frequently.
Here’s the fastest, safest, and most sustainable way to become debt free:
1. Restructure Your Non-Deductible Debt by Rolling Short-Term, High-Interest Loans into Long-Term Tax Deductible, Low-Interest Loans
Assuming you have enough home equity and after improving your credit, refinance your mortgage and roll as much of your non-deductible loans (credit cards, auto loans, etc.) into it as possible. The tax deduction will also increase your cash flow.
CAUTION: Do NOT do any of this if you’re undisciplined and your spending is out of control. If you’re just going to charge your credit cards back up again, you’ll just sink deeper into debt.
The goal is to minimize your interest payments and maximize your cash flow. Then, you can attack your remaining debt strategically, using your increased cash flow to eliminate one loan at a time.
Another benefit of this strategy is that it improves your debt-to-income ratio, which then improves your credit score. An improved credit score can then be used to negotiate lower interest rates and will result in increased cash flow.
Having a better credit score also gives you more negotiating leverage. You can look into a streamline refinance on your existing mortgage. You can call your credit card companies, for example, and tell them you’re considering canceling and switching. They may be inclined to make their interest and terms more favorable for you, especially if you have a higher credit score.
2. The Secret Sauce: Cash Flow Index
Here’s where the rubber hits the road. After minimizing your payments and maximizing your cash flow, you’re now prepared to focus on one loan at a time, thus creating the “snowball effect” until you are completely debt-free.
Most financial advisors and pundits will tell you to pay off your loans with the highest interest rates first. My advice is to ignore the interest rate and use my proprietary Cash Flow Index to determine which debt to pay off first.
To determine your Cash Flow Index, take all your various loan balances and divide each of them by their respective payments. Whichever one has the lowest number is the one you should pay off first.
Home Loan Balance: $228,000
Interest Rate: 7%
Monthly Payment: $1,665
Cash Flow Index: 137 ($228,000 ÷ $1,665)
Auto Loan Balance: $16,500
Interest Rate: 8%
Monthly Payment: $450
Cash Flow Index: 37
Credit Card Balance: $13,000
Interest Rate: 12%
Monthly Payment: $260
Cash Flow Index: 50
Student Loan: $107,000
Interest Rate: 3.9%
Monthly Payment: $650
Cash Flow Index: 165
In this example, it seems to make sense to pay of the credit card first because it has the highest interest rate. But the Cash Flow Index reveals that the auto loan should be paid off first.
The trick is to pay off debt that gives you the greatest cash flow with the least investment. A high Cash Flow Index means your loan balance is high relative to the payment, while a low Cash Flow Index means your balance is low but with a high payment. Knock out those high payments first and you free up cash to work on other debts.
3. Get to the Roots
As I explain in my book, Killing Sacred Cows, without a fundamental change in consciousness regarding debt, none of these strategies will work long-term. Identify and solve the root causes of debt, rather than hacking at the byproducts (interest and bondage).
Garrett Gunderson began his comprehensive financial services firm while still in college, where many of his friends and roommates studied to become dentists. A professional relationship grew when those roommates referred Garrett to the doctors who hired them, which led to them signing up for Garrett’s firm’s financial services. It soon became clear that Garrett’s firm is the best matched – and produces the most success – for dentists than any other type of business owner they work with.