Time for part 2 of our getting out of debt series, paying back your debts. As I said in the previous post, there is no magic pill for fixing your financial situation, you actually have to payback all those bills. Don’t fret, it’s not as hard as it sounds, let’s grab our worksheet we created last time and get started.
Now there’s no real right or wrong here on what to do. Some may say pay down the highest interest rates first because they charge you the most in fees each month, others will say pay the smallest debts first to get rid of them and then there’s the guy in the back yelling Bankruptcy! again and again. Once again, I’ll illustrate how I personally did it, and why.
First you need to establish your goal in this step. Do you want to get out of debt as fast as possible or do you want to conserve as much money as you can while doing it? Lets start with the one that most of the pros like, keeping your money.
Get all of your billing statements. Now take a look at the finance charges for this month. Write them down on a sheet of paper in order from least to most. Do the same for your monthly payments in a neat little column right next to it. Now you can kind of see how bad your interest rate really is. In one case I had a minimum payment of $220 a month, of which $196 was finance charges. That meant that for the $220 I gave them every month, my debt was reduced by $24 and that was at an interest rate of 25%. Seems a little more than 25 to me, but I’m no mathematician.
What I want you to do now is take a look at your finance charges compared to your monthly payments. See where the biggest loss of money is occurring and we’re going to call that Priority one. From this point on, this is your biggest enemy. This is some guy, reaching into your pocket while you sleep and taking money from you. Let’s put an end to him shall we? Finish your list of targets by writing under Priority one the next biggest offenders until you have them all listed and move on to the next section.
Break out the check book(or online bill pay if you were smart enough to listen to my previous posts). Write out the minimum payments to every other debt beside priority one. Now go to your worksheet and see how much disposable income you have. Come up with a number that you can be comfortable with not having in your account this month, the higher the better. Take that number and write it down for priority one, cause that’s how much you’re sending him right now. The more money past the minimum that you send, the faster the debt will disappear. Be sure to look for a check box somewhere on the bill to tell them that any money you send past the minimum is applied to your principle and not to further the payments along, or prepay interest otherwise, you’re kind of just sending them free money.
I’m sure you’ve seen the old Warner Brothers cartoons. Bugs Bunny drops a pea sized snowball down off the top of a large hill and as it rolls down to it’s inevitable meeting with Elmer Fudd’s melon shaped head, it grows larger and larger until that once pea sized snowball is the size of Texas. Good stuff I know, but the point here is that you understand the “Snowball effect”. This is the tool that will get you out of debt faster than paying minimums ever will.
Now that you’re sending money to Priority one at a rate faster than they can charge you interest, it WILL be paid off much sooner than they would like. When it’s paid off, you can now add the minimum payment from this bill to your disposable income every month as you change the balance to read $0.00. If you were sending P1 $100 a month and you have three other bills that require $50, when P1 is gone, you can start sending $150 to the next guy which is 3X the minimum. When that is paid off, you can start sending $200 to the next one, which is 4X the minimum. Each debt that you pay off, the snowball gets bigger before it hits the next debt, so each debt is paid off that much faster and easier that the one before it.
If however you want to pay them off as fast as possible as I did and have no reguard for the amount of money lost over time, here’s how I did it. I listed my balances and interest rates next to each other as in the other example. I called all of my credit card companies and asked for balance transfers from the higher rate cards to the lower ones. I emptied every penny I could from the highest interest rate card and then paid off the balance that month. After my balance was $0.00, I called that high rate card and demanded my rates be cut if they expected me to stay with their card, since the power was all mine at this point(because I owed them nothing)they agreed and lowered my rate from 28.99% to 10.99%. Then I transferred the debts back from the next highest rate card to the now lowest rate and did the same thing to them. Now understand, a balance transfer can cost you up to $50 or more to do, but in my case, the amount of money I was going to save from the horrific interest rates I had was worth it. In the end I condensed my debts from 6 credit cards down to 4 and all at better interest rates. It cost me about $100 in transfer fees, because luckily some of my cards offered free balance transfers at the time. So at day one my monthly payments were reduced by over $80 that now became a part of my Snowball.
After the maneuvering phase, I moved on to paying. I simply took the smallest balance I had, and paid it off first, with the help of my Snowball of course. Month after month, I saved and skimped everyday to build that Ball O’ Snow in to something huge and used it to crush my debts with in a years time. Now, I still have a personal loan, and my wife has a student loan, but those too are well on their way to being buried by this avalanche that we started a year ago. As it stands, all of our credit cards are 100% empty, we have only the two very easy to manage loans left, all of our utilities and monthly bills are paid for us, for free, by our bank every month and we have an emergency fund put away that is 4X our monthly expenses. Although I still try to live a frugal lifestyle for the most part, I don’t have to worry about the creditors attacking me, calling me, suing me or anything else’ing me and I can go ahead and make that occasional purchase to make myself happy, in fact right now I’m looking for a new laptop, because I can. That’s life without stress over money. It isn’t too difficult, and you feel the relief way before your balances hit zero.
Your turn. And be sure to tell me how it goes.
Nex post: I don’t know, I’ll come up with something.