Thursday, July 27, 2006
Get Out Of Debt
I have lost my list of financial pointers, so I'm gonna have to wing it and probably only give out a couple of good pointers. I already gave the disclaimer that this was going to be a very short list of a few "common sense" items that could help some people.
Just like losing weight, where the only way it will happen is to consume less calories than you use, the only way out of debt is to make more money than you spend. Why is losing weight so hard? Because it's so much easier to just eat whatever sounds good. Why is is so hard to get rid of debt, because it's so easy to buy all the cool stuff you want. It is desireable to be grandiloquent.
Step #1 (the most important step): Do not get any more debt. I could tell you about starving children in Africa or homeless folks everywhere to scare you with the "why would you buy an iPod if some people live in a cardboard box" argument, but I'll do even less. Do you need to buy a car more than once every 10 years? Do you need to even own a television? Do you need to update your wardrobe every year? Is it just because everybody else goes into debt to get ahead now? The quote to apply here is "Live like no one else now so you can live like no one else later."
To go along with that just remember that 60 years ago there were no credit cards and department stores ADVISED AGAINST CREDIT/LOANS. Also, if you are, say, 23 years old, out of college and on your own now, then let me ask a question. Why would you try to have the same quality of life as your parents? It took them 50 years to get where they are! How can you expect to have all of that stuff NOW?
Anyway, step 2 is the snowball method for debt elimination (idea from Dave Ramsey). You take all of your debts and order them by how much money you still owe on them. What you do is you pay the minimum amount on every debt except for the smallest of them. Pretty soon that small debt is payed off. You don't get a break in how much you pay now, instead you take that entire payment and "put another layer on the snowball" and make a higher payment on the next highest payment. If you are keeping to the plan and not taking on any more debt, then you can get on top of things after some consistency.
I do, however, have to admit that the snowball method is not mathematically consistent. The reason it works is because it gives periodic psychological micro-encouragement after each debt is eliminated. This helps a person to stay with the debt elimination plan.
However, if you are a "strong enough person" to stick with maximizing how much money you will throw at debt to eliminate it all, you will most effectively eliminate all of your debt by always making your maximum payments on the highest interest rate debts. I will follow with some examples:
The total minimum monthly payments are $1975. So, if you can spend $2000/month, and you start out by NOT buying your new outfit for $75, you will have JC Penney paid off after the first month. Now you can add what you used to pay to JC Penney to the next payment.
I will play devils advocate and show you what happens by paying the higher interest rates instead (using $400 applied to the two credit cards every month).
DEBT SNOWBALL PLAN: PAY THE LOWEST BALANCE FIRST
Card A: $8,000 at 19.8% at $160 per month Card B: $6,000 at 5.9% at $240 per month Total payments equal $400 per month
Card B is paid off in 26.74 months. At that point in time, Card A has a balance of $7,068 to which we start applying payments of $400.
Card A is paid off in another 21.06 months.
Total payoff time is 26.74+21.06=47.80 month
Total payoff cost=47.80 x $400=$19,120
That's $19,120 out-of-pocket cost for the Debt Snowball.
PAY THE HIGHEST INTEREST RATE FIRST
Card A: $8,000 at 19.8% at $280 per month Card B: $6,000 at 5.9% at $120 per month Total payments equal $400 per month
Card A is paid off in 38.96 months. At that point in time Card B has a balance of $2,124 to which we start applying payments of $400.
Card B is paid off in another 5.39 months.
Total payoff time is 38.96+5.39=44.35 months
Total payoff cost=44.35 x $400=$17,740
That's $17,740 out-of-pocket cost paying the highest interest card first.
CONCLUSION
"Debt Snowball" costs $19,120 "Pay highest rates first" costs $17,740
Additional cost for the Debt Snowball is $19,120-$17,740=$1,380 (because it takes over three months longer to repay the debt using this method). ¶ 8:10 AM
Just like losing weight, where the only way it will happen is to consume less calories than you use, the only way out of debt is to make more money than you spend. Why is losing weight so hard? Because it's so much easier to just eat whatever sounds good. Why is is so hard to get rid of debt, because it's so easy to buy all the cool stuff you want. It is desireable to be grandiloquent.
Step #1 (the most important step): Do not get any more debt. I could tell you about starving children in Africa or homeless folks everywhere to scare you with the "why would you buy an iPod if some people live in a cardboard box" argument, but I'll do even less. Do you need to buy a car more than once every 10 years? Do you need to even own a television? Do you need to update your wardrobe every year? Is it just because everybody else goes into debt to get ahead now? The quote to apply here is "Live like no one else now so you can live like no one else later."
To go along with that just remember that 60 years ago there were no credit cards and department stores ADVISED AGAINST CREDIT/LOANS. Also, if you are, say, 23 years old, out of college and on your own now, then let me ask a question. Why would you try to have the same quality of life as your parents? It took them 50 years to get where they are! How can you expect to have all of that stuff NOW?
Anyway, step 2 is the snowball method for debt elimination (idea from Dave Ramsey). You take all of your debts and order them by how much money you still owe on them. What you do is you pay the minimum amount on every debt except for the smallest of them. Pretty soon that small debt is payed off. You don't get a break in how much you pay now, instead you take that entire payment and "put another layer on the snowball" and make a higher payment on the next highest payment. If you are keeping to the plan and not taking on any more debt, then you can get on top of things after some consistency.
I do, however, have to admit that the snowball method is not mathematically consistent. The reason it works is because it gives periodic psychological micro-encouragement after each debt is eliminated. This helps a person to stay with the debt elimination plan.
However, if you are a "strong enough person" to stick with maximizing how much money you will throw at debt to eliminate it all, you will most effectively eliminate all of your debt by always making your maximum payments on the highest interest rate debts. I will follow with some examples:
| Debt | Rate | Minimum | Payments Remaining | Total |
| JC Penny | 7.90% | $17 | 13 | $117 |
| Credit Card B | 5.90% | $120 | 60 | $6,000 |
| Credit Card A | 19.80% | $160 | 64 | $8,000 |
| Car | 8.50% | $400 | 30 | $9,000 |
| Student Loans | 6.00% | $178 | 175 | $18,000 |
| Mortgage | 8% | $1,100 | 342 | $148,000 |
The total minimum monthly payments are $1975. So, if you can spend $2000/month, and you start out by NOT buying your new outfit for $75, you will have JC Penney paid off after the first month. Now you can add what you used to pay to JC Penney to the next payment.
I will play devils advocate and show you what happens by paying the higher interest rates instead (using $400 applied to the two credit cards every month).
DEBT SNOWBALL PLAN: PAY THE LOWEST BALANCE FIRST
Card A: $8,000 at 19.8% at $160 per month Card B: $6,000 at 5.9% at $240 per month Total payments equal $400 per month
Card B is paid off in 26.74 months. At that point in time, Card A has a balance of $7,068 to which we start applying payments of $400.
Card A is paid off in another 21.06 months.
Total payoff time is 26.74+21.06=47.80 month
Total payoff cost=47.80 x $400=$19,120
That's $19,120 out-of-pocket cost for the Debt Snowball.
PAY THE HIGHEST INTEREST RATE FIRST
Card A: $8,000 at 19.8% at $280 per month Card B: $6,000 at 5.9% at $120 per month Total payments equal $400 per month
Card A is paid off in 38.96 months. At that point in time Card B has a balance of $2,124 to which we start applying payments of $400.
Card B is paid off in another 5.39 months.
Total payoff time is 38.96+5.39=44.35 months
Total payoff cost=44.35 x $400=$17,740
That's $17,740 out-of-pocket cost paying the highest interest card first.
CONCLUSION
"Debt Snowball" costs $19,120 "Pay highest rates first" costs $17,740
Additional cost for the Debt Snowball is $19,120-$17,740=$1,380 (because it takes over three months longer to repay the debt using this method). ¶ 8:10 AM
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Oh, if you didn't catch it, either method will be helpful. The thing to catch is to ALWAYS concentrate on one single debt and pay it until it is gone, then move on to another debt. If you evenly make payments across all debts then you will be evenly gaining interest and lengthening how many payments you will have to pay.
i agree with jason (hmmm...have i seen that somewhere before?)
we are living on rice and beans. (and pasta, of course, and the occasional treat...but we are being very frugal for the most part)
we are living on rice and beans. (and pasta, of course, and the occasional treat...but we are being very frugal for the most part)
# posted by 
: July 27, 2006 2:57 PM
: July 27, 2006 2:57 PM
The Total Money Makeover - why didn't you just say it Jason? I have read the book and am convinced that Dave Ramsey is on to something. We don't use credit cards anymore and currently are in the debt snowball, but I'm paying the highest interest student loan first because it bothers me the most. I am tired of putting money in Key Bank's pockets!
# posted by : July 27, 2006 4:35 PM
: July 27, 2006 4:35 PM
Terry,
You just let the cat out of the bag! You have ruined Jason's plan to create a million Jasonites. Now they know he's just using someone else's plan.
You just let the cat out of the bag! You have ruined Jason's plan to create a million Jasonites. Now they know he's just using someone else's plan.
# posted by : July 28, 2006 7:09 AM
: July 28, 2006 7:09 AM
I'm glad you brought that up, Bode. Tis true, tis true. I omitted the "with the exception of your mortgage" rule. In both scenarios (snowball and highest rate) you are supposed to pay off other debts before mortgage. Despite that clause, I am still making a slightly higher mortgage payment every month because I have see how much time it takes off of the total payments. (Make 13 payments a year instead of 12 and a 30 year mortgage becomes a 24.5 year mortgage at current interest rates). Further split those payments up into monthly additions (or bi-weekly) or even add more than 1/12th to see major repayment time decreases.
Jason and I had discussed this offline, but it's worth converting your interest rates into 'tax-effective interest rates'. So your mortgage and student loan rates would actually decrease by the amount of your federal tax bracket.
Jason, you've known for years that I pay my auto-loans and student-loans weekly. (paymentAmt * 12)/52 = the amount I pay every week. Are you actually doing this with your mortgage? Or making a 13th payment? If so, how?
I currently PUSH my auto and student loan payments, but Third Federal PULLS my monthly mortgage payment. How could I set up extra payments under that model?
Jason, you've known for years that I pay my auto-loans and student-loans weekly. (paymentAmt * 12)/52 = the amount I pay every week. Are you actually doing this with your mortgage? Or making a 13th payment? If so, how?
I currently PUSH my auto and student loan payments, but Third Federal PULLS my monthly mortgage payment. How could I set up extra payments under that model?
Just one more thing (Columbo style); it is a lie that having an ongoing morgage payment is a good thing. I completely give this one to D.R. - I heard it on his radio show. He explained that if you are earning tax breaks on your morgage, you are still (A) paying interest to the bank and (B) paying tax on the money you did earn. You normally pay about 100-200% more, overall, on your morgage (so if you have a 100K morgage, you actually pay 300K over 30 years). However, people justify this by the tax break deal...
So, you pay $1000/month on morgage - $12,000 over the year. On taxes, they take the $12K out of your salary (we'll say you earn $50K). So now you are taxed on $38,000 instead of $50K. So you pay $9,000 instead of $12,500. This way you save $3,500 or $105,000 in 30 years, right? NO, wrong!
So, if you keep a morgage payment going, you are paying about $570K in 30 years [(9K X 30)b + $300K]. But, if you eliminate the morgage, you pay about $470K [(12,500 x 30) + 100K]. So, if you have no debt, and just pay the normal taxes, you win. You have about $100K that you can give to charity, and then take a tax break on that!
So, it is always better to have no debt - morgage rule or not.
So, you pay $1000/month on morgage - $12,000 over the year. On taxes, they take the $12K out of your salary (we'll say you earn $50K). So now you are taxed on $38,000 instead of $50K. So you pay $9,000 instead of $12,500. This way you save $3,500 or $105,000 in 30 years, right? NO, wrong!
So, if you keep a morgage payment going, you are paying about $570K in 30 years [(9K X 30)b + $300K]. But, if you eliminate the morgage, you pay about $470K [(12,500 x 30) + 100K]. So, if you have no debt, and just pay the normal taxes, you win. You have about $100K that you can give to charity, and then take a tax break on that!
So, it is always better to have no debt - morgage rule or not.
Well, just keep in mind that I'm an English major, not a math major. I caught the mistakes after proof reading it (which came after posting...lol).
Its so hard paying off debt. We have a good amount.. not a HUGE amount but a large enouch sum that it will take us at this rate til Jan. 2008 to pay off.
We have a good payment plan set up right now with our budget to pay things off by then... and hopefully we wont have any stumbling blocks pop up that will delay that any.
When you have so much money going to credit card payments it makes it hard to do anything else...
Like purchase a bigger car. Our small nissan altima is so cramped.. and with a new baby on the way I'm not excited for the car to become even more crampt haha.
But I suppose we will make due!
wisest thing for us would be to pay off debt first before even looking into a larger car.
::sigh::
but yes it is kinda like loosing weight haha. Although I can loose weight way faster!
We have a good payment plan set up right now with our budget to pay things off by then... and hopefully we wont have any stumbling blocks pop up that will delay that any.
When you have so much money going to credit card payments it makes it hard to do anything else...
Like purchase a bigger car. Our small nissan altima is so cramped.. and with a new baby on the way I'm not excited for the car to become even more crampt haha.
But I suppose we will make due!
wisest thing for us would be to pay off debt first before even looking into a larger car.
::sigh::
but yes it is kinda like loosing weight haha. Although I can loose weight way faster!
In the end I will end up doing a combination of the snowball method and the "pay the highest interest rate" method. I will start with the snowball method to get some extra monthly money available to spend on other debts. Then, once I have some extra money, I will be targetting high interest rates. However, I will heed Bode and DaveDs advice...use the "Effective interest rate", not the interest rate you see on paper before you get tax breaks.
Well, one COULD argue that if your mortgage interest rate was 5.99% and your federal income tax bracket was 25% (making your tax-effective interest rate 4.49%) one would be better to have a mortgage (or keep a mortgage as opposed to paying early) in order to invest the would-be extra money at a historical average of a 9% return. Those gains would be taxed, making your effective gain roughly 7.2%. 7.2% - 4.49% = you're ahead by 2.71%.
Did I do all that math correctly? This may even compound out over years more dramatically.
Did I do all that math correctly? This may even compound out over years more dramatically.
Way to spread the message about the Debt Snowball, bub. It's wild how most joes and jills don't know ... the key to wealth building is to deep-six the debt and connect with the cash. Here's looking at you, kid. www.debtective.com
Saw your blog about free money pal pay - as it is along the same lines I thought I would share this link with you. We were paying far too much for family things like clothes for us and the kids, games consoles inc the new Wii and soon to be PS3, car insurance/home insurance/pet insurance, broadband, mobile phones, landline calls, home and garden items, camping equipment and utilities/loans etc - you name it, we were spending too much on it.
Then a friend of mine recommended a site called www.bargainplace.co.uk. We were able to get cheaper electricity, gas, mobile phone, broadband and loan deals at bargainplace. Thanks to my friend (and the site) I am saving something like £100 a month and can afford an extra holiday abroard each year. Booked of course on www.bargainplace.co.uk. Thanks bargainplace ;-) !!
Then a friend of mine recommended a site called www.bargainplace.co.uk. We were able to get cheaper electricity, gas, mobile phone, broadband and loan deals at bargainplace. Thanks to my friend (and the site) I am saving something like £100 a month and can afford an extra holiday abroard each year. Booked of course on www.bargainplace.co.uk. Thanks bargainplace ;-) !!
# posted by : February 15, 2007 3:50 AM
: February 15, 2007 3:50 AM
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Good blog - very interesting!! I liked it so much I'm going to share this hush hush advice with you. Ever wondered how your neighbours are driving around in their brand new BMW or Mercedes cars - with their kids dressed in all the latest named gear and foreign holidays aplenty?? Well they discovered the secret to the extra online income.
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My website specialises in barclays share price and to drive traffic to my website I was searching around the internet for absolutely ages looking for SEO tools and ffa submission sites to fire my site up the Google search engine - unfortunately these doing work and in fact had the opposite affect plunging my site down the rankings like it had a heavy weight attached!!, then I signed up for this free superb traffic generating tool - I now have loads of hits to my websites/blogs and my site is shooting back up the Google rankings quicker than ever before.
Consequently this saw my affiliate commissions shoot through the roof - meaning lots of extra money coming in for my family - I bought my first Mercedes car on the proceeds of my online campaign.
Sign up now - it's free.. Sorry if this information is of no use to you but seeing as you have the anonymous feature enabled I thought I should share this free bit of essential promotional advice with you and would hope you would do the same for me and others who want to boost their online internet income.
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Best of luck, cheers for now, dave.
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Good blog - very interesting!! I liked it so much I'm going to share this hush hush advice with you. Ever wondered how your neighbours are driving around in their brand new BMW or Mercedes cars - with their kids dressed in all the latest named gear and foreign holidays aplenty?? Well they discovered the secret to the extra online income.
If you are looking for a free tool to attract loads of free links to your blog or website then congratulations I've got the solution for you - and it is FREE!!
My website specialises in barclays share price and to drive traffic to my website I was searching around the internet for absolutely ages looking for SEO tools and ffa submission sites to fire my site up the Google search engine - unfortunately these doing work and in fact had the opposite affect plunging my site down the rankings like it had a heavy weight attached!!, then I signed up for this free superb traffic generating tool - I now have loads of hits to my websites/blogs and my site is shooting back up the Google rankings quicker than ever before.
Consequently this saw my affiliate commissions shoot through the roof - meaning lots of extra money coming in for my family - I bought my first Mercedes car on the proceeds of my online campaign.
Sign up now - it's free.. Sorry if this information is of no use to you but seeing as you have the anonymous feature enabled I thought I should share this free bit of essential promotional advice with you and would hope you would do the same for me and others who want to boost their online internet income.
I hope the tool will serve you equally as well as it has me - it's free!!
Best of luck, cheers for now, dave.
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# posted by : February 20, 2007 4:28 AM
: February 20, 2007 4:28 AM
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: April 24, 2007 7:36 PMSubscribe to Post Comments [Atom]
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