1 - Spend less than you earn
“The second vice is lying; the first is denying you’re in debt.” –Benjamin Franklin
“Someone stole all my credit cards, but I won’t be reporting it. The thief spends less than I did.”-Henry Youngman
“Debt” is a four letter word which stands for – Definitely Expect Big Trouble.
“Every time you borrow money, you're robbing your future self.”-Nathan W. Morris
“If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.”-J Paul Getty
“We all think we’re going to get out of debt, until is too late.” – Louie Anderson
“We didn’t actually overspend our budget. The allocation simply fell short of our expenditure.” — Keith Davis
“Too many people spend money they earned...to buy things they don't need...to impress people that they don't like.” ― Will Rogers
“Ninety percent of my salary I spent on stuff that I want … and the other ten percent I wasted.” – Tug McGraw
“It is easier to tell our therapist about our sex life than it is to tell our accountant about our finances.”-Vicki Robin
When will be the day you’re financially debt free? Many people will never see that day because they keep carrying debt after debt.
“There are only two things certain in life: death and taxes. And there are only two things certain in this economy: debt and taxes”
The “G. O. O. D.” plan (Get Out Of Debt)
Are you stressed about your finances and losing sleep at night? Debt is a major problem for a lot of people these days as we live in a consumer economy. Every day you face pressures and appeals to spend for this or that, and sometimes even for worthy causes. The problem is, even if we know we want to get out of debt, we have a hard time figuring out how to start. This is where you need the willpower to keep from spending the money reserved for your future freedom.
Many people who have debt blindly make their minimum payments each month without a single thought about paying off the debt. The “G.O.O.D.” plan (Get Out Of Debt) starts with admitting that you have a debt problem, don’t be ashamed to tell your family and friends. By showing them your interest in reducing the debt you have taken the first stride to getting out of debt. The next step is the commitment to do whatever it takes to get out.
Remember: They say most people don’t plan to fail, they fail to plan. Wrong! I think they fail to act.
Credit card debt can carry interest charges in the 18% to 22% range. Clear up credit card debt before you even think of saving money. There’s no reliable way for you to earn 18% to 22% interest on your money than just paying off your credit card. If you have a knack for charging up a storm and spending more than you should with those little pieces of plastic, only one solution exists: Get rid of them, go cold turkey. You can function without them and you might be surprised how easy it is.
Remember: In this case cash is king, studies shows that you spend more with plastic. Part of the reason behind this is the disassociation factor: you don’t feel as if you’re actually parting with money when you swipe your card at a terminal, especially if you don’t have to face the bill for a month.
Revolving credit vs. Closed-end credit
Revolving credit is debt that typically has a variable interest rate, which means that the interest rate can change and is also called an open-ended term, which means that it has no end date. It can be considered a perpetual loan as long as you pay the applicable fees and make your minimum monthly payments.
Payments are based on a percentage of the balance and the minimum payment can change from month to month. Usually the payment is 3% of the amount owing or $10, whichever is greater. Examples include most credit cards, home equity lines of credit and overdraft protection for checking accounts.
As you repay the debt, the amount you’ve paid becomes available for you to borrow again. Very convenient, but it is also very easy to abuse. It should only be used with discipline. Borrowing to make purchases that you really cannot afford and then taking too long to repay the debt is how most people get into financial trouble.
Closed-end credit is debt that typically has a fixed interest rate, which means that the interest rate does not change. It has a specific term, which means that it has a specific end date; it is expected to be repaid in full over a definite time as long as you pay the agreed set number of equal payments.
Payments are based on the present value of the debt/loan and interest rate and are usually made monthly. Examples include most mortgages, auto loans or debt consolidation loans.
Let’s say you have a debt of $5,000 and an interest rate of 20%
Under revolving debt your minimum payment should be 3% of the outstanding balance (3% of $5000 = $150) or $10, whichever is greater. Now keep in mind that as you go your balance will decrease over time and as a result your monthly payment amount will decrease over time as well (3% of $4000 = $120), therefore extending the final repayment day. In this scenario it will take you 20 years and 11 months and you will have paid $5,992.55 extra in interest.
Under fixed debt your equal payments are $150 (start at the same level as above) and will stay the same until the outstanding balance is repaid. In this scenario it will take you 4 years and 2 months to pay it off and you will have only paid $2,358.95 extra in interest.
By making fix payments, you save yourself 16 years and 9 months of grief and have $3,633.60 more in your pocket.
Calculations link (Excel spreadsheet)
Remember: It’s not how much you pay in interest; it’s how long your money is exposed to it.
Restructure your debts into one, combine outstanding debts (mortgages, car loan, department store cards, and credit cards) using collateral. In some cases your bank will be able to lower your high-interest rates to a more affordable one if you explain to them your goal is to pay off your debt. This will allow you to manage your finances more easily, and to make just one affordable payment each month. Make payments every time you get paid, weekly or biweekly because smaller amounts seem less painful, but add up as quickly. Make sure the amount that you pay is not less than what you were trying to pay before. If it is you should avoid the temptation to just add it back into your spending money. Save it, otherwise you will not have gained any benefit. Don't stop there, once you become debt-free, continue your program by saving.
Remember: If you are in debt, debt repayment should be you primary focus to take care of your future.
You can calculate your debt ratio (amount (E) from the “How to get there from here (Spend less than you earn)” section) by adding up all of your monthly debt payments and divide by your gross monthly income. This ratio is the percentage of your income that goes towards your required debt payments or basically is how much trouble you’re in every month.
If your monthly minimum required payment is $1200 and gross monthly income is $3000, your current debt-to-income ratio is 0.40 = 40% ($1200/$3000).
15% or less = Excellent
16% to 20% = Safe
21% to 35% = Fair
36% to 50% = High
51% or more = Big trouble
Some adviser will tell you before tackling debt repayment you should make a budget to take control of your money. A budget is a balance sheet where you write down what you earn and what you spend, so that you can come up with a strategy to spend less and save more. Every month you have to review your numbers to make sure you're on track. Below is a rough percentage that advisers would suggest regarding your expenses:
I don't particularly agree, keeping up with a budget is a pain in the butt if you ask me! People get carried away with numbers and ultimately you will find out that your budget doesn't balance. There are too many unpredictable monthly expenses and sometimes there are expenses that just pop up unannounced. Every month is different than the other (car repair, friend’s birthday, Christmas, accidents, household maintenance, honey do’s, etc.). Don't get me wrong, there are only two ways you can pay down your debt: increase your income or decrease your spending. Let me ask you this…Who is more important: your monthly bills or yourself? Because I am self-centered, my advice to you would be to incorporate your savings as an expense. What I mean by that is to pay yourself first as if you were the repo man.
Make yourself an expense
1- Separate needs & wants
Sometimes it's hard to separate needs from wants and to practice the self-control necessary to plan for having life's "extras". The result is dream-shattering debt, but it doesn't have to be that way. Here’s what you should do: write down on one piece of paper your needs or what is important to you… paying your debt off, for example. On another piece of paper write down your wants or the things that are not so important. Once you’re done throw out the “wants” sheet and focus on the need to pay your debt first.
Usually, people receive their pay check, pay their bills and then try to save the nickel that is left. If this is your approach, how has that been working for you? Focus on paying your debt first by automatically making fixed payments to it. Eventually, once the debt is gone you should keep going with the same automated system towards your savings.
2- Make fixed payments
Pay yourself 25% (as per the budget guidelines: 15% Debt +10% Savings) of your gross salary or at the bare minimum calculate 3% of your total debt (excluding mortgage and car loan). Either of these amounts will be the fixed payment you must pay yourself from now until your debt is paid off and beyond. You might be thinking this is crazy now! “It is too much money!” What is amazing about human beings is their flexibility; believe me you will find a way to adapt to the short-fall.
Imagine this scenario: Times are tough and the economy is in a recession, unemployment is sky high. Your employer, to keep business going, has proposed to cut your pay by 25% or cut 25% of the employees and you’re one of them. What would you do? Sit down and cry or take the cut of 25% and then figure out how to make ends meet? If this situation actually happened to you and you were in debt, you wouldn't want to be out of a job and have bills to pay and family to feed; you would take the pay cut.
I've seen people living paycheck to paycheck and one month that income is a little less than the previous month but they still manage to get to the end of the month. What that tells me is regardless of your disposable income you will still be able to make ends meet.
Be honest with yourself and your list of “needs”. If you think you can get out of debt sooner? Give yourself a raise!
3- Do it automatically
If you’re building your discipline, stop finding excuses not to pay yourself each month. To completely eliminate the temptation, have the money electronically transferred from your checking account on the same day you are paid. If you can’t get your hands on it you will never miss the money and your debt will disappear sooner. Setup an automatic bill payment with your Bank or online banking.
How to get there from here (Spend less than you earn):
___ Promise yourself you will follow the “G.O.O.D.” plan and do whatever it takes get out of debt. Write it down; write yourself a letter for future reference and motivation. Write down your goals regarding your finances.
___ Admit that you have a debt problem and say it out loud, especially to the ones close to you, family and and/or friends.
___ Commit yourself to do whatever it takes to get out of this mess. Tell your friends you’re taking control of your spending if you’re in this situation.
___ Cut up your credit cards.
___ Calculate how much debt you have. Student loans, VISA card, Line of credit, IOU’s to friends and your parents… don’t forget your parents.$_____________ TOTAL DEBT
___ Calculate 3% of the amount above. $_____________ (A)
___ Calculate your gross (before taxes) monthly income using your most recent paystub or your latest income taxes.$_____________ TOTAL monthly INCOME (B)
___ Calculate 25% of the amount above. $_____________ (C)
___ Write down the greater amount of (A) or (C). $_____________ (D)
___ Calculate your Debt/Income Ratio buy dividing your monthly debt payment by your gross monthly income. Just keep this number as a reference for the future. (D/B) _____________% (E)
___ Call your Bank and any of your creditors and tell them you want to consolidate your debt and make fixed payments. Some of them will convert your revolving credit into closed-end credit. This implies that you will be in fixed payment installments and your rate may also be reduced.
___ Setup an automatic bill payment with your Bank or online banking to make those payments.
___ If you have a mortgage and you’re making monthly payments: Call your Bank and negotiate to change your payment schedule to bi-weekly. You can shave years off your mortgage and save thousands of dollars in interest.