My friend was bummed out. He had been watching and listening to Dave Ramsey and Suze Orman. He told me that their advice sucked because if he did what they told him to do, it would take forever to pay off his debt. He was never going to be able to save his way out of debt.
The problem was that my friend made too little and his debt was too big. His debt to income ratio was too high.
It comes down to math. If you owe $800,000 and only make $80,000 after tax each year, even if you save 50% of your income, it would take you 20 years to pay down the debt. Actually a few years longer than 20 years because you would also need to pay the accumulated interest on that debt.
Alternatively, if you owe $500,000 but are able to save 50% of your $200,000 income, then in 5-6 years, you should be debt free. How much of your income you can save to pay off the debt is almost as important as the amount of debt.
Expense and Income
The complete formula to eliminating debt is to reduce your expense and increase your income, while using the difference to pay down your debt. And of course, avoiding new debt.
I can understand why Mr. Ramsey and Ms. Orman would focus their message on reducing expense. We have more control over our expenses than over our income. And let’s face it, we are wasteful with our spending so there is a lot of fat which can be trimmed. We can cancel the $100/month cable subscription a whole lot faster and easier than asking our boss to give us a 5% raise.
Eventually, we would trim down to the bare necessities and no more. All meals would become, as Mr. Ramsey says, “beans and rice”. Then it becomes a question of how much pain and for how long we can withstand that pain before the debt is paid off. My friend was not willing to scrimp, save, and suffer for a decade or two. I don’t blame him.
More Debt, Please
So we are left with increasing income. While your job may give you raises gradually over time, it may be much quicker to change to a higher paying job. Maybe work overtime, take on a second job, or do a side hustle (drive for Uber and Lyft).
My friend correctly pointed out that the above was just a different form of suffering. I would have suggested going back to school to switch to a career with higher pay, but that is what he already did and a reason why his debt was so high (two student loans). And I would have suggested declaring bankruptcy but bankruptcy does not discharge student loans.
Years ago, my friend had decided to take a radical, counter-intuitive solution to get rid of his debt. This solution involved reducing income and increasing expense. He had decided to start a business to sell a revolutionary new product. He had reduced the amount of hours he worked at his job (reducing his income) so he could spend time developing the product. And he had taken on additional debt to cover the development cost and unexpected living expenses (another reason why his debt was so high).
My friend is taking a risky approach to reducing his debt, but the business is his passion and he is very persistent, so I expect him to eventually succeed. His income would then skyrocket and paying off his debt quickly would be possible.
In the end, it comes down to how much pain or risk a person is willing to take to pay off debt. If you can take the pain, intensive saving may be your best long-term bet. If you can take massive risks, then starting a business or new high-paying career (while your debt continues to balloon) might be the ticket to a big payoff.