Banish Debt Like a Boss: Demystifying Personal Finance Part 2
Welcome to Part 2 of our Demystifying Personal Finance Series! Debt repayment is a crucial step in attaining financial freedom and I originally wrote a post about debt repayment myself. But, it was terrible. Since we’ve never had any debt other than our mortgage, it was full of conjecture about what it “must feel like” to have debt and work towards paying it off. Be glad you didn’t have to read it.
Mr. Frugalwoods and I instead came to the conclusion that we shouldn’t write about what we haven’t experienced. And so, we invited Kim Parr, from Eyes on the Dollar, to share her personal experience and wisdom around debt repayment. We’re delighted to have her here on Frugalwoods today!
By: Kim Parr, Eyes on the Dollar
I’m honored to be in the midst of the Frugal Weirdos today talking about how to pay off debt. Hopefully, many of you have avoided debt like a greyhound avoids bathing, but for those who struggle with monthly payments and credit card spending, this post is for you.
My husband and I found ourselves stuck with over $30,000 in credit card debt a few years ago. To say it was stressful would be like saying this winter in Boston has been chilly. It ruled our lives until we took control. Today, I’d like to share how we paid off debt and how I believe you can too.
Tracking Spending: The First Step In Any Get Out of Debt Plan
Do you often find yourself scratching your head at the end of the month because it seems like there should be more money left? The only way to really know and fix your spending leakage is to keep track of every penny that comes in and out. It’s pretty easy these days with sites like Mint or Personal Capital.
One thing all people in debt have in common is that their spending is greater than their earnings. I guarantee you’ll be surprised at how crazy some of your spending actually is once you sit down and track the money. We had no idea we were spending $1,000 a month on food or $300 a month on entertainment. In our heads, it seemed like much less. You can’t argue with numbers and that’s why tracking spending is so important. After you have an honest picture of where the money is going, you can finally make a realistic plan to get out of debt.
Being Emotionally Ready To Pay Off Debt
Anyone can focus themselves for a period of time to achieve a certain result. This is true with weight loss, education, skills training, or paying off debt. The problem with having a laser focus for the short term is that it’s not sustainable without the emotional maturity to make it stick for life.
We had several trial runs with paying off debt. Twice, we paid our credit card balances down to zero, but weren’t ready to change the way we thought about money. As a result, we rebounded back into debt within a few months. How did we change our habits and make debt freedom stick?
Making Specific Goals
Saying you want to get out of debt is too broad. It’s like saying you want to be rich or you want to quit your job. Lots of people want these things, but few take the time to know why.
In our case, I wanted to get out of debt so I could work fewer days in the office and be able to spend more time with our daughter. My husband, Jim, wanted to go back to school and eventually work in education administration. We couldn’t withstand the salary and stability variation these goals created until we got out of debt.
As secondary goals, we wanted the security that debt freedom brings. Without debt, it’s fine to take some time off or have a low income month. You have options. But if the almighty monthly debt payment hangs over your head, the options are work, work, and more work.
Give Money A Purpose
Does your money work for you or do you work for your money? The easiest way to give money a purpose is to make a budget. If you’ve never budgeted, it can be a challenge, but after awhile you’ll get so good at it that you might not even need to budget anymore.
Be realistic. If you’re used to spending $1,000 a month on food and decide to set your budget for only $100, you will fail. This might lead to discouragement and giving up altogether. Instead, start small and work your way up.
Once you know how each dollar is helping you get to the place you want to be, it’s much harder to commit acts of mindless spending.
Cut Out What You Can
Now that you know where your money goes and how much you want to budget for monthly expenses, it’s time to take a long, hard look at expenses. Some spending might be habitual and painless to remove. Things like subscriptions or memberships you don’t have time to use are no brainers. Calling your internet or cell phone provider for a lower rate takes minutes and can save hundreds of dollars. Question everything you send a payment for and ask if it’s possible to pay less.
When we were in debt, I bought lunch every day from the grocery store salad bar. I thought it was a healthy option and much less expensive than going out to eat in a restaurant. The truth was that I usually spent $10 a day on lunch plus whatever other items I decided to pick up while in the store. That adds up to $50 a week or $200 or more a month! I found that if I buy produce to make my own salad at home instead, the cost per lunch drops to about $1 per salad AND I’m not tempted to buy other things because I’ve removed myself from the store.
I also realized I can color my own hair for about $8 as opposed to the $80 the salon charges. No, DIY is not as relaxing as having someone do it for you, but the cost difference speaks for itself. Find what expenses you can cut or lower from your own budget. Once you’ve found them all, look again. I’m always finding new tips and tricks for lowering our bills.
The other huge part of cutting expenses is mental. Instead of feeling deprived, tell yourself that each dollar you save is a dollar more toward your goal. Also, never say you can’t afford it. You can afford it, you are simply choosing to use money in a more productive way.
It’s fairly easy to keep yourself in check at home, but what about socially? Many people in debt have a lifestyle that includes spending with friends and family, better know as Keeping Up With the Joneses. This one was hard for me because I’m naturally a people pleaser.
You can be honest about your quest to pay off debt or you can simply tell friends and relatives that you are saving money for a big goal. In our case, we never told family about our debt. We didn’t want sympathy or to make ourselves look superior because we were chucking debt to the curb. We knew it would be a hard road and one we would likely walk alone. We found our support in the amazing online personal finance community.
Those who are real friends will support your decisions and might even join in the fun. Those who won’t probably aren’t the friends you need to keep. You can’t change your family, but you also don’t have to go over the cliff with them if they don’t support your new lifestyle. Please yourself and stop worrying about the rest of the world.
Making More Money: The Real Key To Paying Off Debt
It can be a joy and a downer to lower all monthly expenses. The good part is that most people can save a few hundred dollars by cutting expenses. The rough part is that if you’re like us, with tens of thousands of dollars to pay back, it’s still going to take a really long time to get out of debt.
Sometimes the sheer thought of spending years to pay off debt is enough to cause people to give up. I used to say that I would owe Visa for the rest of my life, so why not enjoy it? The problem is that you can’t really enjoy life with credit card debt hanging over your head. Anyone who tells you differently is lying!
The real way to knock debt on its fat keister is to earn more money. With your new frugal lifestyle and with more dollars coming in, you will really start to see those balances falling faster than opponents of the Kentucky Wildcats (Yes, I’m from Kentucky. Go Big Blue!).
If you’re wondering how to tap into this treasure trove of extra cash, don’t reinvent the wheel. The easiest way to make more money is to continue doing what you’re good at, just do more of it. In my case, I took an extra optometry job. Your claim to fame might be consulting, website design, online writing, cleaning houses, walking dogs, or washing cars. There’s no limit to what people will pay you to do.
It sucks to spend what limited free time you might have doing extra work, but keep the end goal in mind. If a few more hours of work per week in the short term gets you out of debt forever, it’s time well spent. I worked at my extra job for 18 months until I got to use a paycheck for anything other than debt. Every penny went to Mastercard, Visa, and American Express. Some months it was depressing beyond words, but it taught me the secret of extra income. Now, there’s no limit to what I’m able to do.
Debt and Beyond
It took us 18 months to pay off over $30,000 in credit card debt. If you do the math, that’s about $1,800 per month toward principal and interest. Once that debt was gone, we had lots of extra money every month. After finally learning the value of a dollar, you can bet we didn’t go on a spending spree. Instead we started investing in our future.
It’s been almost three years since we paid off our credit card debts once and for all. Jim did get his master’s degree in administration and is now an elementary school principal. His salary is now more than double what he was making during our debt payoff journey. I sold my optometry practice and currently spend about three days a week on eyeballs. Strangely, even though I’m working about half the amount of hours, I make more money now than when I owned a practice.
From the sale of my business, we were able to pay off our other pesky debt, which came in the form of student loans. We’ve leveraged Jim’s extra salary to buy rental properties and now own five residential units and one commercial property. All of those will be paid off within the next eight years.
I also make an extra $5,000-$10,000 per year with blogging and online writing. I honestly started a blog to document my journey and never planned on making a penny. It’s funny how things start falling into place once you have a purpose and a plan to make it happen.
Our new purpose is to retire in nine years when I’m 50 and Jim is 54. It’s not sexy, like retiring at 30, but our plan should still give us plenty of years to live life on our terms. Considering where we started, it makes me downright giddy to know we won’t have to work until we’re old and gray (well, I’ll never be gray because I’m so good at home hair color now!)
If you struggle with debt, today is the best day to start working toward the future. Even though society gives its blessing to those who live by monthly payments, I can say with 100% certainty that life without credit card debt is a million times better.
Kim Parr is an optometrist, blogger and reformed spender. She loves foster dogs, helping people get out of debt, real estate, and enjoying the outdoors with her family in Southwest Colorado, not necessarily in that order. Find out more about her at Eyes on the Dollar.
Mr. Frugalwoods’ Technical Nerd Corner
Since I love spreadsheets, and also can’t help myself, I wanted to include a discussion of the methods and math behind the debt payoff equation.
Consolidate Debt If Possible
If you have student loan debt, see if you can consolidate and refinance it into a lower interest rate. This is often an easy win, and in addition to paying less interest, there’ll be less complexity around your monthly payments.
Once you have your debt consolidated (if applicable), it’s time to accelerate paydown. No sense in paying interest for the entire length of a loan, so let’s get it out of the way now!
Pick A Payoff Method
There are two prevailing theories about the “best” way to pay down debt: the Avalanche Method and the Snowball Method.
For both methods, the first step is determining the minimum monthly payment on each debt. Next, figure out how much extra money per month you have to put towards your debt.
The Avalanche Method states that you should put all extra money towards your highest interest rate loan. Once you pay it off, move to your next highest interest rate loan. Use all the money you were putting towards your first debt and put it towards your next debt. Each time you pay off a debt, the amount of money you have to dedicate to debt repayment grows.
The Snowball Method espouses picking your smallest dollar amount loan and focusing all effort towards paying it off. Once you pay it off, move to your next smallest dollar amount and focus all of your money towards paying it off.
Mathematically, the Avalanche Method comes out ahead. Using that plan you’ll pay less interest and eliminate your debts sooner. Usually, it’s not much less interest or that much sooner, but, there is a mathematical advantage.
However… I often counsel friends to go with the Snowball Method. Why? A combo of two benefits:
- It’s psychologically rewarding to pay off debts entirely. Paying off two $5,000 debts makes people feel more accomplished than paying off $10,000 of a $30,000 debt. For many people, debt repayment is going to take a long time and anything that makes them more likely to stick with the program is valuable.
- Snowballing frees up monthly cash flow, giving you money for stuff other than loan payments–for example, an emergency fund. For most folks, paying off a few smaller loans in their entirety puts them in a less precarious financial situation month-to-month.
Two exceptions to the “pay down debt now” rule
Exception 1: Low interest rates. If your debt is locked into a super low interest rate (which I define roughly as anything under 4%), it might make more sense not to pay it off early and instead invest that extra money. The theory being that if you can get a better return out of the stock market than you can from paying back your debt, you should go for it.
There is, of course, the risk that your invested money won’t grow at the rate you forecasted. Thus, this strategy isn’t for everyone, and you’ve got to gauge your own comfort level with risk before deciding to invest rather that accelerate debt payback.
Exception 2: Free Money. If you’re eligible for a 401K match from your employer, it often makes sense to invest enough in your 401K to receive those matching funds even if you have high interest rate debt. Hard to beat a 100% return on investment!
The risk with this strategy is that your 401K contributions are locked up for many years, while your debts demand repayment now. If you tend to live close to the financial edge, you’ll probably be better served by paying back debt even if you are giving up delicious matching funds.
Banish Your Debt
Whatever method you pick, knocking out debt as fast as possible is essential to your future financial success. Debt is an anchor weighing you down. Think about how amazing it would feel if a year from today you looked at your finances and realized you’d cut your debt in half… or paid it off completely! Start today, be fearless, and don’t hold back. No debt is safe from your repayment vengeance!
What’s your experience with paying down debt?
Never Miss A Story
Sign up to get new Frugalwoods stories in your email inbox.