autocad lt discount Reader Q & A time! How exciting! This week, we answer IN DETAIL a question from a reader who is screaming “HELP ME PAY MY DEBT”. This is a specific question from real-life readers, and the advice is specific to their problem. However, I’m confident that the answer will be helpful and applicable for anyone trying to pay their debt.
microsoft frontpage buying The Question: Help Me Pay My Debt
Its a long question, but here it is in full:
Well, no need to skirt around the facts, I made plenty of asinine decisions in regards to my finances at a young age with no regards for the future. That being said, I’m tired of being so overwhelmed and thinking things will work themselves out eventually. I want to create a rock solid plan, something concrete (with room for the unexpected) that I can hold myself accountable to, that in the end sees me out of debt and better at money managing, possibly with a good strong credit score as well!
The problem: My income has taken some cuts over the past 2 years and prior to the cuts I was still living beyond my means. This leaves me with very little room to pay my debts down quickly which causes me to stress out every time something unexpected happens (even something small) which throws a big wrench in my plan and causes me to borrow more.
I’ve tried consolidating as much as I can and just recently paid of a very high interest loan and credit card, which felt great, but it was mainly just moving money and not ACTUALLY lowering my overall debt. I’ve applied for personal loans through some lending sites to no prevail:
My current position is as follows:
Gross Income: $32,000 annually
Net Income: $24,000 annually – $2,000 per month.
- Car Loan Principle Balance: $18,900 * 6.3% APR (First loan w/o a co-signer)
- IRS Back taxes from 2008/11: $3,900 (currently paying no interest)
- CC #1: $2,042 x 18.99%
- CC #2: $1,396 x 24.99% (Retail Card)
- CC #3: $917 x 12.99%
- CC #4: $877 x 0.00% (ends May 2014 after will be 19.99%)
- CC #5: $792 x 0.00% (ends July 2014 after will be 25.99%)
- CC #6: $800 x 0.00% (ends July ’14 after will be 18.99%)
- Rent: $275
- Insurance: $75
- Utilities: $60
- IRS Installment: $50
- Internet: $25
- Cellphone: $15
- Xbox live: $8
Sub Total: $508
- Food: $??
- Gas: $??
- Misc: $??
My expenses above do not include my debt payments. My car repayment has a minimum repayment of $353.
Question: What’s my best plan of action to get on track, establish a savings, pay off my debts, and get my act together?
You’ll notice I don’t even budget for gas, groceries, or any other expense. I know I’m not in the worst situation but I still feel stressed out as all hell. Thanks in advance!
Sheldon, Missouri, USA.
What a great question to start us off. Thanks Sheldon. To answer this properly, we are going to have to break it down into a few steps of how you are going to pay down your debt.
Pay My Debt – Step 1: Make Your Budget
The first thing you need to do is create an accurate budget. The good news is that you are already almost there. If you need a template, may I recommend the net worth and savings rate tracker used in the Moneystepper Savings Challenge. The savings rate tab is essentially created to make and constantly review your budget:
Let’s look at the categories that you haven’t addressed.
Gas & car maintenance – $100. There is no way that I could have estimated this figure, so I got back in contact with Sheldon to ask about this figure. He told me that he travels around 7 miles to work each day and this is the only commute he performs. Therefore, we have estimated this cost to be around $100 per month.
Groceries – $250. I personally think you can live on even less if you really scrimp and save, but $50 a week for a single person is about reasonable.
Other expenses (including “fun”) – $100. You need to get by. And you probably will eat out or have a drink after work every now and again. But, whilst you are in this financial position, you must do everything you can to minimize these expenses.
This leaves us with: Net Income – $2000 ; Fixed Expenses – $508 ; Variable Expenses – $450
Net cash before debt repayment each month – $1058.
Pay My Debt – Step 2: Improve your budget
The first thing for us to do is to determine if we can reduce our expenses by losing those discretionary items, or reduce costs on necessary expenses. In general, however, I would say that your budget looks pretty lean. Utilities are low. Internet is very low. Cell phone is very very low. Well done for being frugal on these expenses. I’m going to ask you to cancel the xbox membership, but that’s about it.
Revised net cash before debt repayment each month – $1050.
Each month you should inspect your actual costs against the budget. This way you can determine whether you are overspending or if your budget needs to be revised for essential costs. I have included a VERY simple budget format in the spreadsheet attached below for this purpose. You should add your own lines to this as you go. Alternatively, you could use a free online budget software. Your choice.
Pay My Debt – Step 3: Emergency Fund
I’m not usually one to advise building up large emergency funds whilst you are in debt for two reasons:
1) It might not ever happen, and usually does not.
2) If it does happen, you can usually borrow money to pay for the emergency when it occurs.
This is a fairly controversial opinion, but one I have written about in a LOT more detail here:
Generally, it is advised that you have between 3 and 6 months to cover these expenses. However, given your currently personal situation (you are fairly young, you don’t own a house, etc), I would suggest we aim for less than this amount.
Therefore, the first thing to do is build up an emergency fund of over $1,000. Given the budget worked out above, after 2 months, you will have around $1,250 in the emergency fund (see below for further details) which should suffice for now.
Pay My Debt – Step 4: Paying Off The Debt
It’s interesting isn’t it that on the step-by-step guide, actually tackling the debt is the fourth step. As Winston Churchill said:
The next thing that you need to do is to tackle your debt. And tackle it really bloody hard.
Let’s not underestimate this challenge. There is going to be a long, hard road ahead. But, treat it as a challenge, not a chore. Each debt you eliminate will be a “win”.
So, how should we approach this game?
When paying down debt, there are generally two schools of thought. Avalanche (pay highest interest first) vs Snowball (pay lowest interest first). I go into this in detail in the article linked below, but (in my opinion) avalanche is better. End of.
Therefore, your first game is against the CC #2. It is the highest interest bearing debt and therefore should be paid off first. Then, work through all your other payments. However, don’t forget that you will need to make the minimum payments on all your cards as you go.
We start off with two payments of $1050 which pay down the interest only and minimum on the car loan, with the surplus ($626 each month) going into an emergency fund.
From then on, we pay down the highest interest rate loan.
Points to note:
- We must pay off the 0% balance transfer amounts just before the 0% rate expires.
- We pay off the IRS taxes before the car loan. The longer we leave the IRS repayments, the higher the possibility of incurring penalty charges. You should speak to the IRS directly to determine exactly what the possible penalties and interest payments are. You should then revise the above spreadsheet to pay these off when required.
The repayment of the loans once we are completed can be summarized as follows. Note that the interest paid reflects the entire amount of interest incurred on those loans during the repayment period
We can see, therefore, that our total interest payments are reduced to approximately $2,555.
If you continued to just pay the minimum each month, your interest payments over this same period would have totaled almost $7,000. Moreover, you still would have had the full capital amount of around $30k to pay off.
So, you need to work really hard. You need to be really disciplined. But, in under 3 years you can be entirely debt free.
It means 3 years without a vacation. Tough? Yes. But after the 3 years, you will then have $1,050 each month that you previously used to pay your debt. You can use this to pay towards fun things like vacations, eating out, and most fun of all, INVESTING!! Woo!
Pay My Debt – Additional Considerations: Debt Consolidation
Right now, you have a lot of loans to pay down. However, I see that you have recently been able to open a 0% balance transfer credit card. I will assume, therefore, that you have the ability to do this again and your credit score has not been too damaged.
For example, the Tesco 0% balance transfer account in the UK (I am sure there are similar offers in the US) has no annual fee and no interest on balance transfers for 12 months. This sounds good, but each transaction you perform has a “handling fee” of 0.9% of the transaction amount. Therefore, we need to look at each transaction separately to see if this is worthwhile.
By transferring CC#2, for example, it would cost us $1,396 x 0.9% = $12.56. However, in the example above, you can see that we paid interest of $108.91 on this loan by paying it off. Therefore, this should be consolidated. Here are a list of all the credit card loans:
You can see that it is beneficial to transfer the amounts on credit cards #2, #1 and #3.
Therefore, let’s revise our repayment plan to the following:
In month 1 & 2, we make the minimum payment on the car loan, pay our handling fees of $39.20, and the rest is placed into the emergency fund. After month two, our emergency fund is approximately $1,350, which should be enough for now.
Then, we start paying off the loans with the highest interest, still ensuring we pay of 0% balances before they expire.
This reduces the total interest paid below $1,950 (saving us over $600 compared to our original repayment plan) and means we are debt free one month sooner.
Therefore, you should apply for a balance transfer card today and transfer all your high balance amounts to this card (within the 60 day period allowed). Once you have been accepted, you will need to revise the repayment plan to focus your repayments on those loans still paying interest. Remember, you MUST pay off all the 0% balances before their expiration date, as the rates on these cards are very high following the introduction offer.
Pay My Debt – What Else Can You Do?
Well, we have focused attention above on minimizing your expenses. One other variable in the equation is your income.
If you could increase this figure in the short to medium term, it would allow you to pay off these loans much quicker and reduce the interest amount paid yet further.
For some ideas, please refer to some of the previous posts on this site:
- Online surveys – easy way to make extra income
- Swagbucks – earn money for using the internet!
- Writing online – make money through online articles
- Find me a parking space – make money renting a driveway
- That’s a wrap – advertising on your car
- Rent a room – house share to earn extra income
- Car share to drive up that bank balance
Pay My Debt – Conclusion
So, I hope that answers your question Sheldon.
If you have a similar question, or want to work through your own debt repayment approach, please do not hesitate to leave a commend below, or send me an email at email@example.com.