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Money Problems – Day 7: Paying Off Debt
Today, I am continuing the series, Money Problems: 30 Days to Perfect Finances. The series will consist of 30 things you can do in one setting to perfect your finances. It’s not a system to magically make your debt disappear. Instead, it is a path to understanding where you are, where you want to be, and–most importantly–how to bridge the gap.
I’m not running the series in 30 consecutive days. That’s not my schedule. Also, I think that talking about the same thing for 30 days straight will bore both of us. Instead, it will run roughly once a week. To make sure you don’t miss a post, please take a moment to subscribe, either by email or rss.
On this, Day 7, we’re going to talk about paying off debt.
Until you pay off your debts, you are living with an anchor around your neck, keeping you from doing the things you love. Take a look at the amount you are paying to your debt-holders each month. How could you better use that money, now? A vacation, private school for your kids, a reliable car?
If you’ve got a ton of debt, the real cost is in missed opportunities. For example, with my son’s vision therapy being poorly covered by our insurance plan, we are planning a much smaller vacation this summer–a “staycation”–instead of a trip to the Black Hills. If we didn’t have a debt payment to worry about, we’d have a much larger savings and would have been able to absorb the cost without canceling other plans. The way it is, our poor planning and reliance on debt over the last 10 years have cost us the opportunity to go somewhere new.
The only way to regain the ability to take advantage of future opportunities is to get out of debt, which tends to be an intimidating thought. When we started on our journey out of debt, we were buried 6 figures deep, with a credit card balance that matched our mortgage. It looked like an impossible obstacle, but we’ve been making it happen. The secret is to make a plan and stick with it. Pick some kind of plan, and follow it until you are done. Don’t give up and don’t get discouraged.
What kind of plan should you pick? That’s a personal choice. What motivates you? Do you want to see quick progress or do you like seeing the effects of efficient, long-term planning? These are the most common options:
Debt Snowball
Popularized by Dave Ramsey, this is the plan with the greatest emotional effect. It’s bad math, but that doesn’t matter, if the people using it are motivated to keep at it long enough to get out of debt.
To prepare your debt snowball, take all of your debts–no matter how small–and arrange them in order of balance. Ignore the interest rate. You’re going to pay the minimum payment on each of your debts, except for the smallest balance. That one will get every spare cent you can throw at it. When the smallest debt is paid off, that payment and every spare cent you were throwing at it(your “snowball”) will go to the next smallest debt. As the smallest debts are paid off, your snowball will grow and each subsequent debt will be paid off faster that you will initially think possible. You will build up a momentum that will shrink your debts quickly.
This is the plan I am using.
Debt Avalanche
A debt avalanche is the most efficient repayment plan. It is the plan that will, in the long-term, involve paying the least amount of interest. It’s a good thing. The downside is that it may not come with the “easy wins” that you get with the debt snowball. It is the best math; you’ll get out of debt fastest using this plan, but it’s not the most emotionally motivating.
To set this one up, you’ll take all of your bills–again–and line them up, but this time, you’ll do it strictly by interest rate. You’re going to make every minimum payment, then you’ll focus on paying the bill with the highest interest rate, first, with every available penny.
DOLP
This is the plan promoted by David Bach. It stands for Done On Last Payment. With this plan, you’ll pay the minimum payment on each debt, except for bill that is scheduled to be paid off first. You calculate this by dividing the balance of each debt by the minimum payment. This gives you an estimate of the number of months it will take to pay off each debt.
This system is less efficient than the debt avalanche–by strict math–but is better than the snowball. It give you “quick wins” faster than the snowball, but will cost a bit more than the avalanche. It’s a compromise between the two, blending the emotional satisfaction of the snowball with the better math of the avalanche.
Snowflaking
For each of these plans, you can give them a little steroid injection by snowflaking. Snowflaking is the art of making some extra cash, and throwing it straight at your debt. If you hold a yard sale, use the proceeds to make an extra debt payment. Sell some movies at the pawn shop? Make an extra car payment. Every little payment you make means fewer dollars wasted on interest.
Paying interest means you are paying for everything you buy…again. Do whatever it takes to make debt go away, and you will find yourself able to take advantage of more opportunities and spend more time doing the things you want to do. Life will be less stressful and rainbows will follow you through your day. Unicorns will guard your home and leprechauns will chase away evil-doers. The sun will always shine and stoplights will never show red. Getting out of debt is powerful stuff.
Your task today is to pick a debt plan, and get on it. Whichever plan works best for you is the right one. Organize your bills, pick one to focus on, and go to it.
Assuming you are in debt, how are you paying it off?
First Steps – Ramsey was Wrong
Baby Steps” width=”180″ height=”240″ />- Image by bonnie-brown via Flickr
Fixing a lifetime of financial mistakes can be an intimidating process. Scratch that. It’s always an intimidating process. Where do you start? You’ve got a pile of bills, a dozen messages from bill collectors and two bi-weekly paystubs. What next?
Traditionally, and according to Dave Ramsey, the first step to fixing your finances is to make a budget, but he and tradition are wrong. The first step is to get everybody involved in your finances on the same page. If your spouse isn’t on board with paying off the debt and spending responsibly, nothing else will work.
Once you have that out of the way, you can move on to the traditional first step, making a budget. I’ve gone over my process to build a personal financial plan in quite a bit of detail, so I’ll just hit the highlights this time.
First, make a list of all of your expenses. Include all of your utilities, debt payments, tax payments and absolutely everything else. You need to know the amount of the payment and the frequency. If a bill is due quarterly, divide it by three and you’ll know what you need to set aside each month. Round up in all cases so you can build an automatic cushion.
Next, make a list of your income sources. For most people, this is far easier than tracking their expenses. Figure out your monthly income. If you get paid weekly, that that amount times 52, then divide by 12 to get your monthly income.
Finally, subtract your expenses from your income. If your total is a positive number then you are golden. If you total is negative, you have been a bad monkey. You need to make some cuts, and they may be painful. If your outgoing money is more than your incoming money, it is not possible to get ahead.
Once you have your income and expenses recorded, and you have made the cuts necessary to have a positive balance at the end of the month, you have a successful budget. Congratulations!
5 Ways to Change Your Spending Habits
If you keep doing what you’ve always done, you’re going to keep getting what you you’ve always gotten. One of the hardest things about getting out of debt is changing your habits. You need to break your habits if you’re going to get yourself to a new place, financially.
How can you do that? Habits aren’t easy to break. Ask any smoker, junkie, or overeater what it takes. There are a lot of systems to break or establish habits, but they don’t all work for everyone.
Here are my suggestions:
- Commit to just 30 days. I’m a big fan of doing new things for 30 days. If you can do it for a month, you can do it forever, no matter what “it” is. For just one month, don’t buy anything. I don’t mean avoid buying groceries or toiletries and I certainly don’t mean to stock up on new crap the day before your 30 day spending fast or rush out for a shopping spree on day 31. Just don’t buy anything for a month, no exceptions but the things necessary to stay alive and healthy. No movies, no games, no cars, no toys, and no expensive meals. Just 1 month.
- Switch methods. If you pay for everything with a credit card, restrict yourself to just cash. If you pay cash for everything, switch to a credit card. Breaking your long-established habits is a way to get used to spending consciously: taking the time to think about what you are doing, instead of just spending mindlessly.
- Identify your spending triggers. I can’t go into a book store and come out empty handed. So, I avoid bookstores. My wife has problems with clothing stores. A friend can’t walk out of a music store without some body piercing equipment. What are your triggers? What makes you spend money without thinking? Figure out what those things are and then avoid them like the plague…or the clap.
- Quit buying things for pleasure. Buying things makes us feel good. It sends a rush of endorphins through our bodies. The more we get that rush, the more we crave that rush, so the more we do to get it. You need to stop that. Before you buy something, ask yourself if it’s something you actually need, or if you just want a pick-me-up.
- Avoid shopping online. E-commerce sites make it far too easy to buy things at a moment’s notice. You don’t have to think about what you are doing or if you actually need whatever you are buying. You just buy. The best way too avoid them is to delete your credit card information from any site that save the information and delete the sites from your bookmarks. Whatever you can do to slow down the buying process will make it easier to avoid buying things, which can soon be stretched into NOT buying things at all.
Habits—especially bad habits—are hard to break. There is an entire self-help niche dedicated to breaking habits. Hypnotists, shrinks, and others base their careers on helping others get out of the grip of their bad habits, or conning them into thinking it is easy to do with some magic system. How do you avoid or break bad habits?
5 Things to Do in the New Year
- Image via Wikipedia
CNN Money has an article up on 5 things to do this year. After posting a similar article a couple of weeks ago, I thought it’d be interesting to post about someone else’s perspective.
1. Shop for a no-fee checking account.
If you are paying fees for a checking account, go somewhere else. There are so many alternatives available that you shouldn’t be throwing money away. Ally Bank has a great no-fee checking account, as does INGDirect, though ING won’t let you write paper checks against the account. The same principle applies to credit cards. If you have a card with an annual fee and you aren’t getting some monster services or rewards to go with it, run away.
2. Save your raise.
I don’t necessarily agree with this one. If you are in debt, it’s better to use the raise to pay off that garbage, first. When I got my last raise, I immediately boosted the automatic payment for my car to use every new penny. I’ve never had the money available, so I haven’t missed it. Whatever you do, fight lifestyle inflation. Just because you have some more money doesn’t mean you need to spend it. At my last job, I got a substantial raise, so I bought a new car, only to get laid off a few months later.
3. Go for a checkup
Wealth doesn’t matter if you squander your health. Go get a physical. Every disease is easier to treat if you catch it earlier as opposed to later. Don’t make the mistake of running your body into the ground. You will regret it later. Effective this year, most health plans will cover a physical with no copay, co-insurance, or deductible allowed.
4. Score a better rewards card.
B***-****. If you’ve still got debt, don’t concentrate on using more of it. Get that crap paid off. If you’re out of debt, look into getting a rewards card that aligns with your goals. If you like to travel, get a card that gives you frequent flier miles. Otherwise, I’d go with a cash-back rewards card.
5. Use your vacation days.
37% of Americans don’t take all of the vacation to which they are entitled. That’s insane! We work harder and better when we have time to recuperate and relax. Unfortunately, I usually fall into that unfortunate 37%. My vacation resets on February 1st, and this will be the first year in a lot of years that I haven’t had to roll it over or even lose some.
What is your financial plan for the new year?
Tips to budget successfully
This is a guest post written by Andreas Nicolaides, a financial author for UK based MoneySupermarket.com.
Whether your aim is to save money for a special occasion or you just want to make sure you don’t have to struggle financially when it comes to the end of the month, a budget can be a saving grace. Budgets help us quickly and easily identify our total income and all our expenditure, allowing us to plan for the best and prepare for the worst financial situations.
Set yourself a target
If you have decided to set up a budget, then there must be a reason. Are you looking to save for an upcoming event? Or maybe you have realised that you are struggling to make your payments every month and you would like to feel more financially secure. Based on what you would like to get out of your budget, you should set yourself a specific, measurable objective.
My first objective I set for myself was to save $100 every month for a year. This sort of objective is easy to manage and easy to monitor and this is what we are trying to achieve. One important thing I would mention here is to ensure your objective is achievable; don’t set yourself a target that is too far out of your reach, being realistic is extremely important.
How do you set up your budget?
The main key thing when you start to put your budget together is to make sure you’re as honest as possible. Get yourself a pen and some paper and on one page detail all of your income. Include the obvious and also remember to include any benefits you are entitled too. Then grab another piece of paper and detail all of your monthly outgoings, remember to be honest and thorough and try not to forget anything. Once you have both figures, deduct your expenditure from your monthly income that will give you your monthly figure.
You have some extra cash?
If when you have your figure you realise that there is some cash left over, you can then decide what you want to do with it. My advice here depends on your own personal circumstances, for example if you have high levels of debt, your main aim should be tackle your high interest debt aggressively and as often as possible.
If you have some money left over and your aim is to save, then set up an interest bearing bank account. If you are based in the US then you could look to set up an LSA or lifetime savers account. In the UK we have the equivalent, that is called a cash ISA saving account.
No money left over?
If after working out your budget you find you have no money left over, then you need to do something about it. Debt is one of those things that won’t just disappear overnight; it’s something that takes time and commitment, but not giving up is paramount.
How to cut down your expenditures?
One of the main things you can do when you realise you are in a bad situation is to try and cut down on your expenditure. Here’s a couple of quick ways:
- Use price comparison sites – These sites are great to check and see if you are paying too much on your bills, and if you are, you will have a list of fantastic options available for you to choose from. This is a great way of saving money on things like your car insurance, see here.
- Sell unwanted items – Selling unwanted items is a quick way to making some cash, everyone has them around their home, so why not make use of them instead of letting them build up dust?
- Cut down on your spending – Try to avoid buying luxuries and try to stick to a specific shopping list when out doing the weekly food shop, this will help you avoid unnecessary purchases
A budget is used by many just to monitor what they spend month to month, but I hope I have detailed how it can be a helpful financial tool that can help you reach your financial goals. I hope my tips to budget successfully will help you get started on your way to financial freedom.
