Some thoughts on financial management, budgeting, getting out of debt, etc.

It takes time. You need to be organized, and take the time to keep track of your finances.

It can seem overwhelming at first. When someone is thousands of dollars in debt, sometimes they would rather just not think about it. That only makes the situation worse, because if you don’t figure out exactly how much you make and how much you owe, you cannot create a plan to get out of debt.

First steps:

1. Net Worth: Know where all your money is, and how much there is.
-Some people have multiple checking/savings accounts, and may not even know how much is in each account. Consolidate multiple accounts. Use your bank’s website to keep tabs on your account balances.

2. Income: Figure out how much you make. (net salary, after taxes, on a monthly basis)
-Don’t include overtime or odd jobs if they can’t be counted on for regular income.

3. Expenses: List all of your regular expenses. (mortgage/rent, car payments, other loan payments, utility bills, phone/cable/internet, magazines, food, gas, etc.)
-For expenses that don’t occur once a month, figure out the monthly equivalent. (expenses for total year, divided by 12)

4. Liabilities: Add up all past due bills. (we’ll come back to this one after Step 5)
-List your debts in ascending order, for the smallest amount owed to the largest amount
-Be aware of interest rates, late fees, service charges, etc.

5. Balance your budget.
If your expenses (#3) are more than your income (#2), then you need to aggressively reduce your expenses and/or increase your income. Increasing your income isn’t always within your control, but reducing expenses usually is. TV, internet, cell phones, magazines, movies, etc., are all optional expenses that may need to be eliminated. You may need to find strategies to save on gas money and food. You may decide you can’t afford your current car or residence, and need to trade down. You may need to find a second job. Do whatever it takes to make sure that your income is greater than your expenses.

6. Manage expenses.
Now that you have a budget that allows you to live within your means, you need some structure to keep your spending under control to make sure you stick to your budget. This is why keeping track of your spending habits is important, so you don’t get to the end of the month and realize (too late) that you’re out of money. Many people find it helpful to use an envelope system. At the beginning of each month, take out the budgeted amount of cash for food, gas, entertainment, and other discretionary expenses, and put each amount in it’s own envelope. Use only the allotted cash to make your purchases (don’t write checks or use your credit card). If your food money runs low, you’ll have to eat peanut butter and jelly for a while. If your gas money runs low, you’ll have to stay close to home for a while. If you don’t use all your gas money in a given month, don’t just blow it on something else: save it, or use it to pay off debt.

7. Pay down debt.
While you’re creating your budget in Step 5, it’s important to not just have your expenses be equal to your income, but to have your expenses be less than your income. This excess income is used to create savings and pay off accumulated debt. It is often recommended to eliminate your smallest debts first, and work your way up, but sometimes the debt with the highest interest rate or highest late fees should get top priority. Once a debt is payed off, don’t treat the money you were paying as being freed up for other expenses, roll it over into paying off the next debt.

This is the step that people are often the most worried about, but without doing Steps 1 through 6, Step 7 will never happen.

1. Establish a Spending Plan based on a temporary, spartan lifestyle. This frees up every possible dollar for the top priority of debt reduction.

2. Determine whether any nonessential assets can be sold. Cash from the sale of assets can be used to give the debt repayment process a kick-start and provide the initial buffer to ensure success.

3. List your debts from smallest to largest. Do not pay attention to the interest rate of the debt.

4. Pay the minimum payment on all debts and the maximum additional possible on the smallest. The goal is to pay off smaller debts quickly. This will give a sense of accomplishment as well as simplify the process as the number of creditors is reduced.

5. As each debt is paid off, roll the total amount you were paying to the next largest debt. Add that amount to the minimum payment you were making.

6. Continue this strategy until all debts are paid. Do not reduce the total amount going to debt repayment as some debts are paid off. It is the snowball effect of rolling the previous payment into the next largest debt that gives this system its power.

7. Incur no new debt, period! Discipline will be necessary in this regard. Be creative. Have someone hold you accountable. Ask for God’s help.

8. Discard credit cards. Get rid of them. If you must have a card for travel or emergency, have only ONE.

9. Reward yourself occasionally but modestly. As progress is made and milestones are reached, it is appropriate to reward yourself. For some, the progress itself may be reward enough.

Here is an example:

Let’s say you have four outstanding loans, which are shown here ranked in ascending order, along with the minimum payment for each. Let’s assume that after paying the minimum required payment for all bills, there is $50 leftover each month that can be used to pay off debt.

Lender…Amount Owed…Min Pay…Add Pay…Total Pay
Bill 1…$100……….$10…….$50…….$60
Bill 2…$500……….$30…….$60…….$90
Bill 3…$3000………$50…….$90…….$140
Bill 4…$12000……..$200……$140……$340

At first, the $50 additional payment is applied completely to Bill 1. In two months, that loan will be paid off. Now take the entire $60 that was being used for Bill 1, and use it for Bill 2. Once Bill 2 is paid off, take the entire amount that was being used for Bill 2, and apply it to Bill 3. Once Bill 3 is paid off, take the entire amount that was being used for Bill 3, and apply it to Bill 4.

TIPS:
-Eliminate multiple credit cards, and do everything possible to reduce interest rates. (However, don’t take out a consolidation loan unless you cut up and eliminate ALL credit cards.)
-Have your pay direct deposited into your checking/savings account.
-Utilize budget plans offered by many utility companies. This does not change your overall expenses, but spreads them evenly across the entire year so monthly expenses remain consistent. (This is different from locking in at a fixed rate, which could end up costing more.)
-Drop or reduce discretionary insurance (you have to decide what’s truly necessary. Possible options are life insurance, collision/comprehensive automobile insurance, etc.)
-Once your budget is consistent and you can count on having the money in your account, sign up for bills to be directly debited from your account. This eliminates the hassle of writing a check, and prevents late fees due to forgetfulness.

Two others tidbits related to finances… (not necessarily related to getting out of debt)

-New federal laws require credit reporting agencies (Equifax, Experian and TransUnion) to provide 1 free credit report per year. (For a total of 3 per year: 1 from each company.) You have to request it though, they won’t just send it to you. You can request all 3 at once to compare them side-by-side, or you can request one at a time every several months to keep tabs on your credit report throughout the year. It is a good idea to review your credit report periodically, to make sure you don’t have open accounts that you have forgotten about, and to make sure there is no strange activity that you did not authorize.

The site for requesting your free credit report is http://www.annualcreditreport.com. When you submit your request, read the details carefully, because they offer additional options that cost extra. The basic credit report is 100% free and will not require you to enter any payment information. This site should not be confused with freecreditreport.com or other sites that offer “free” credit reports in return for signing up for their credit monitoring service or other products/services.

-The following quote is from a Money magazine article about organizing and simplifying finances:

A recent study by New York University professors Andrew Caplin and John Leahy along with John Ameriks of Vanguard’s Investment Counseling and Research group found that people who have control over their finances–particularly those with the propensity to plan and budget–are, on average, 39% wealthier than their less organized peers.

It pays to be organized!