Get out of debt without going broke

For most Canadians, it’s almost impossible to reduce spending to bring it in line with earnings. Statistics Canada reports the ratio of household credit-market debt to disposable income hit 163.7% for the quarter ending June 2013.

That means clients must reduce spending by about 64%. While carrying debt isn’t sustainable, asking consumers to take a huge chunk of money out of the economy isn’t smart either.

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Fortunately, debt can be managed without sacrificing spending. Clients just have to manage their cash and create income. This approach is far more effective and sustainable than cutting back, because it encourages clients to use systems to alleviate stress, as well as manage the flow of money in and out of their lives.

The process starts with a cash flow forecast instead of a budget. The forecast demonstrates how much income the client needs to fuel financial goals and wants, and when.

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Next, leverage these strategies.

1. Find out where the current debt came from. Ask clients the following:

• What did you spend the money on? Why?
• Over what period of time did you accumulate the non-productive, non-deductible, consumer debt? This will identify spending priorities, lifestyle interests and desires, and differentiate between lifestyle debt and credit use, which assists in income and wealth creation.
• What’s your monthly earning and spending gap?

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For example, let’s say your client has $12,000 in credit card debt, which was accumulated over five years. He spent that money on family sporting activities. This works out to an earning/spending deficit of $200 per month for an activity that the family values.

2. Develop a cash management system that efficiently uses banking and other financial resources. Set up bank accounts with an earnings allocation strategy that builds in rewards, plus puts savings, debt management, lifestyle expenses and day-to-day spending on autopilot. By pre-determining what percentage of income is allocated towards current obligations and desires, a client’s priorities are taken care of without him having to make these decisions every time he gets a paycheque.

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Get clients to establish habits for using cash and organize outstanding debts into a debt snowball. This means outstanding debts are prioritized. One debt is targeted at a time so that it can have as much surplus cash directed towards the principal. The idea is to start with the lowest balance (not the highest interest) and pay the most the client can afford. All other debts are simply maintained with minimum payments until it’s their turn in the payment priority plan.

When the first debt is paid off, its payment gets combined with that of the second debt in the priority plan. Each successive debt essentially gets larger and larger payments. This accelerates debt repayment.

For instance, one of my clients consolidated her bank accounts. She set up one primary operating account and a separate cash account for debit transactions, and this saved her $60 per month. The money was then applied to non-deductible debt in a snowball strategy.

3. Look for ways to create the income so clients can maintain their current lifestyles, as well as manage cash flows to maximize tax and interest efficiency. This strategy isn’t simply to go out and get another job. It means advisors have to help clients recognize what their earning/spending gap is, and then encourage them to find ways to create small amounts of income from their interests, passions and skills. Sometimes, this requires small investments to cover start up costs. But expenses that are incurred to create income are tax deductible.

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Earning a few extra hundred dollars a month in passive income from an entrepreneurial venture doesn’t have to be time consuming, complicated or expensive. And the result can take care of certain financial needs and desires, like dining out, far more effectively than finding lump sum quick fixes or restricting spending.

When you help clients combine all three strategies, they increase their overall financial capacities because they’ve developed systems that support sustainable income. This fuels client confidence, and in turn is good for your business, the client and the economy.

Tracy Piercy, CFP is the founder of MoneyMinding. She is an author, speaker and financial educator providing books, training, courses and materials for both advisors and clients to help create sustainable income and increase financial capacity.