Following the feedback from My Money, why not continue sharing our adult, real life problems.
Alright this time, we talk about debts. I feel like tackling this is a major key to unlocking so much potential for a lot of new adults like myself. The more I think about it, I could argue that people in debt are the most generous people in this life, they are just giving it to the wrong people. These people work so hard JUST to give their money to financial institutions. If you think about it, the moment you create debt you've accepted to pay for something AND give your creditor (the bank) a bonus for it.
My Debt Philosophy
You can wander your way into debt, you can't wander your way out. - Dave Ramsey
Think about this; how easy is it to save $1000? How about how easy it is to spend $1000?
I feel like a lot of us have gotten ourselves into really bad situations and refuse to admit it. I think, admitting the problem and taking ownership of your stupid stuff is solving half the problem.
I AM in the reason I AM in debt.
Not because school fees are expensive, not because buying a house is expensive, not because everybody is doing it, not because the interest rate was low, not because the monthly payment was affordable, not because it was zero down, not because it was on sale, not because it was a really good deal, not because OMG Savings!
I don't think ALL debt is all bad. I think on a monitored and manageable level, it can help. Mortgages, school loans, business loans aren't bad. However, the thing with personal finance is the PERSONAL piece of it. It is 80% behaviour, 20% math. It is 'PERSONAL' that makes us forget to do mathematics before making math decisions.
- PERSONAL is why you take out student loans to study papier mâché in sunny Vancouver, when could have studied it where your family lives in Ottawa.
- PERSONAL is why you take a loan to go on a vacation to Mexico instead of saving for it and going next year.
- PERSONAL is why you don't know how much you've spent until the credit card bill shows up.
- PERSONAL is why your credit card is maxed each month.
- PERSONAL is why all you do is swipe.
- PERSONAL is why you start looking for receipts to return stuff when bills hit.
- PERSONAL is why you act shocked when your card declines.
Again, there is absolutely nothing wrong with making some personal decisions AS LONG AS the math is not out of wack.
For example, you just started a new job as a new grad in a new city, you need to bridge a week between your first pay hitting your account and your need to buy groceries for this week. Nothing wrong with using a credit card to pay for that week's grocery shopping. You'd have 21 days(from your next statement date) to pay it back, no interest IF you pay it in full. You have considered it in the budget for that month and it works fine with your cash flow, I don't see why not.
Now, same example, you moved and you suddenly discover you 'NEED' a new couch. The one you moved with is no longer worthy of your now elite working class status. Let's just go and buy that new $2,999.99 one. it's on sale! You can just apply for the store credit card, use that to pay for it and also take 10% off! No interest for 90 days! You can pay it off later! It's a great deal, right??! No, don't do it.
Why get out of debt though?
- OMG! STRESS!
- Bills! Bills! Bills!
- Where do I even start?
- I'm pretty sure I paid this one last week, didn't I?
- Didn't I pay this yesterday?
- Where did all this stuff on my statement come from?
- Is that a collections letter?
- See number 1.
- Outside of giving away money with interest payments, you have so much peace of mind. Nobody is going to call talking about, what's your payment plan sir? (Let me be honest, I've never had anything in collections, I have overheard a call though. It is undesirable)
Imagine for a minute;
What would you do if you had zero debt? No payments off your paycheck?
- You wouldn't have to do imaginary math and figure how choosing between the 3pc chicken or 5 pc chicken is going to affect your rent this month.
- You wouldn't need to think if the gym membership has taken their direct withdrawal from your account yet?
- You would give outrageously; If you're like me and you enjoy giving stuff, you could go out for a birthday dinner with a group of friends and pay for the celebrant anonymously. Ask the waitor for the bill and be quiet about it, pay it quietly, and just watch the celebrant be confused to where their bill is with a huge smug on your face. While I'm on this, have you ever left a BIG tip for the waitor before? OMG! You gotta do it one time. One time. It's a great feeling to give.
- Another reason to get out of debt; if you don't get out now, when will it happen? When you have children? Oh, bae will pay it for you? You're marrying a bank? Nice nice nice.
- When will you start saving for your 'goals'? Loads of people tweet, like and share stuff with the caption "Goals." If you don't start now, will it ever happen or will you show your children a facebook post?
- Let's now assume you're actually even saving, you could save more to get to your future goals faster. You could in theory, SAVE everything other than your living expenses and look forward to building your glorious wealth empire. Money shovel anyone?
- Now the real life math example, you're making $2000/month (I keep it simple).
You start paying $400/month on a new car for the next 84 months. New grad, gotta have a new car. How else will they know you've made it?
That is $1600 to do the rest of your month.
You have student loans, about $300/month.
Now we're down to $1300.
Gotta pay rent (I can't see how any bank will give you a mortgage), car insurance, food, gas(petrol for the British english folk).
$300 to go (at best).
AND you have this month's credit card bill to pay off? (Can't pay it in full, but let's pay above the minimum $10)
Say you & your friends did a once in a lifetime after-graduation trip or your friend got married, you took a small loan, now you gotta pay back.
You're young you want to have fun with friends every once in a while. You're cute, you do what you want when you poppin'
wow. $100 (again AT BEST) left.
Oh snap, you haven't paid the internet bill yet.
Phone bill hits. you went over your data limit, AGAIN!
What do you have left?
I'd say, you work too hard to live life like this.
Debt Elimination Strategy.
STEP 1: BELIEVE
You have got to make that decision first that you want to get in control of this. You have to want it for you. You NEED to want it for you. It is going to be a long but rewarding road so you will need that resolve to get you out of debt.
No matter how small, how great, until you decide it's time to come out of debt you will continue staying where you are. You won't have hope it will be gone unless you believe that you can. You are the alpha and omega of your money problems. You can and You will!
STEP 2: Know the Opponent and focus
So now, we want to get everything in control. We need to know what we are up against. Write every single one of your debts down. One by one.
Put it in a spreadsheet somewhere. Example,
Name | Total Amount Owing| Interest Rate| Minimum monthly payment.
Car | 18000|0.99|400
Student loan | 40000|3.75|463
Credit card |2000|19.99|10
... You get the picture.
Stop investing in stocks or funds when you are paying 20% on a credit card balance. Don't be talking about 'free' money with RSP match or whatever other investment perk you get from wherever. You are clearly losing more money than your investment(s) can keep up with.
STEP 3: Get on a budget
It always seems to come back to getting one of these eh? If we are not on a budget, if we don't know where our money is going, we can't stay on top of our finances. We will keep being the hamster running in circles and getting nowhere fast.
Decide at the beginning of the month where we want our money to go before we get it, give every dollar an assignment so we know we can't touch it for the wrong things.
SET aside a debt freedom part of your budget. $100, 300, $400, $1000 whatever you are comfortable with. You can't stop yourself from living because you want to be out of debt.
STEP 4: Get a small Emergency/Life Happens fund.
We don't want to go back into debt while trying to get out. Life happens and life happens quickly. Get a good $500 - $1000 in savings as quickly as possible. Sell stuff if you have to. Get it and make sure you can't spend it with your card too. Increase your savings if you know your expenses are higher than what $1000 can comfortably cover.
STEP 5: Choose between Behaviour modification or Math.
So this is where it gets interesting, there are two really popular ways of eliminating debt. One is called the debt Snowball, the other, the debt Avalanche.
With the debt snowball, you rank debts smallest to largest in total debt amount.
You pay the minimum payment on EVERYTHING. Then pay extra on the smallest one. You keep doing this till the smallest one is fully paid off.
When the smallest debt is out of the way, you roll over the extra payment you were paying on the smallest one AND the minimum payment you were paying on that smallest debt to the next smallest debt.
You continue this till you get to the largest debt. As you go through your debts, you get the minimum payments from old debts as extra money to focus towards the next debt. This is what causes the snowball effect. You get some quick and early wins, you now have motivation to keep going and getting out of debt. It feels good, your plan is working, and you start adjusting your lifestyle because winning with money feels great.
In the case of the avalanche, you list debts in order of interest rate, highest interest rate first to lowest interest rate last.
You do the exact same thing, pay minimums on everything BUT this time, pay extra on the debt with the highest interest rate.
This way you effectively pay the least amount of interest. However, it is likely you may not see results as quickly especially if your highest rate is on a larger bill.
You can check here to see what the difference is in interest payments either approach makes in your journey out of debt and choose accordingly.
I'd also suggest a guilt free approach, where you pay debts that affect you emotionally first. Like paying off a debt you owe a friend before paying a credit card bill, that type of stuff.
Remember, Personal finance is about your person more than the math quite frankly.
STEP 6: Stay Out of debt
Once you've gotten back to zero from your days in the negative, do you really want to go through all this again?
I have assumed you have no dependents or you have no reason to think a major financial storm is coming. If you're about to be fired/laid off or your contract is about to be up, stop paying more than minimums on your debts, stock pile as much cash as you can. This way you can pay for things with the money you have saved. DO NOT go further into debt.
Once things stabilize financially, resume your debt free journey.