THIS IS PART 2 OF A 3-PART SERIES
In the last post, I talked about How to “Cashflow” Your Way Out of Bad Debt in 5 Simple Steps…
Today we take a closer look into the Cash Flow Index and see how it can accelerate your loan repayments in the most efficient way possible.
The average American household has $16,883 of debt in credit cards and $137,063 in total debt.
Even more alarming is that many people, motivated to pay off their debts more rapidly, take on debt-reduction methods that negatively affects their cashflow.
The Cash Flow Index (CFI) is a ranking system to help you identify the score(or efficiency) of each of your loans. This allows you to pay off the most inefficient loans first. Then you will know exactly which loan to pay off next to maximize your results.
Why Should I Care?
How you go about paying off your debt can have a incredible effect on your financial security and wealth building potential.
I’ve found out over the years that a strategy that favours cash flow always wins.
That’s why the Cash Flow Index works so well. It pays off your outstanding debts from a cash flow perspective first. Then it systematically eliminates debt one by one while still allowing you to enjoy the fruits of your labor.
The Cash Flow Index I will show you today will not only help you erase debt safely and quickly, it also allows you increase your cash flow and live to the fullest today.
How Does It Work?
To figure out the Cash Flow Index of your loans, take all your outstanding balances and divide each of them by their respective minimum monthly payments:
A high number (90+) means the loan is efficient. A low number (under 50) means it is inefficient.
So whichever loan has the lowest CFI number is the one you should focus on paying off.
99% of people will focus on the highest interest loan but that is not the fastest way to do this.
It doesn’t matter what the interest rate is on the loan. The most important thing is how efficient it is, which is what the Cash Flow Index allows you to figure out.
It may seem counterintuitive at first.
But results are the only thing that matter.
Here Is An Example
Let’s say you have the following loans:
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 ($16,500 ÷ $450)
Credit Card Balance: $13,000
Interest Rate: 12%
Monthly Payment: $260
Cash Flow Index: 50 ($13,000 ÷ $260)
Student Loan: $107,000
Interest Rate: 3.9%
Monthly Payment: $650
Cash Flow Index: 165 ($107,000 ÷ $650)
Investment property loan balance: $50,000
Interest Rate: 5.5%
Monthly Payment: $2,000
Cash Flow Index: 25 ($50,000 ÷ $2000)
It may seem to make sense to pay off the credit card first because it has the highest interest rate.
In fact, most financial advisors will always tell you to focus on the highest interest rates first.
I’ve discovered that ignoring the interest rate and using the Cash Flow Index gives you superior results.
By taking out the inefficient loans first, you free up a ton of cash flow to work on other loans. This has the intended “snowball” effect of eliminating them in order, in the most efficient way.
In the case listed above, paying off the investment property loan (CFI of 25) first frees up $2000 per month.
So if you have extra cash to put towards that, put it all toward that loan first.
Next up would be retiring the auto loan (CFI of 37) which then frees up $450 per month. This can then be applied toward the credit card balance (the third lowest CFI).
Paying off the investment property loan and auto loan first means you can pay off both faster than if you started with the credit card, or try to pay them off equally.
What About Loans With a CFI above 50?
Once you’ve payed off your inefficient loans (those with a Cash Flow Index under 50), it’s time to look at the remaining debt.
Any loan with a CFI between 51-100 is a good target for restructuring. Look at last week’s article for tips on how to do that.
For example, you may be able to negotiate a lower interest rate, lengthen the payment schedule, or consolidate the balance into a more efficient loan.
Any loans you have with a CFI score over 100 are cash flow efficient. There’s really no need to be paying more than the minimum on them.
In fact, trying to pay down efficient loans (like making double payments on a home mortgage with a high CFI) instead of saving or investing that money could negatively impact your cash flow. More on that in the next post.
The best part is that once you have all your inefficient loans paid off or restructured, you can start making extra investments with the freed up cash flow.
And in the next post, I’ll show you exactly how to do that with the Investment Cash Flow Index.
What To Do Next
Eliminating inefficient loans is one of the quickest and safest ways to reduce your debt and increase your monthly cash flow, and the CFI is the best tool we’ve found to make it simple.
With that in mind, here are your action steps to consider today:
- Apply the Cash Flow Index formula on all of your loans.
- Choose the loan with the lowest CFI score to tackle first. Make minimum payments on all your other loans and redirect all the extra dollars to the one with the lowest CFI.
- Rank the other loans in order, from lowest score to highest. Consider restructuring loans with a score of 50-100. Loans over 100 are efficient and don’t need any attention.
- Use the Investment Cash Flow Index (revealed in the next article in this series here), to find inefficient investments you may be able to use to pay off inefficient loans faster.
- Celebrate your debt-reduction victories along the way. Be sure to put a percentage of your newly created cash flow into enjoying the fruits of your labor and treat yourself.