Debt 1.0

The Numbers

  • Thirty percent of Millennials would sell an organ to get rid of student loans.
  • Baby Boomers view debt more positively than Gen Xers and Millennials; millennials have primarily student loan and car debt.
  • Median percentage of American households with debt: 80%.
  • The average American credit card debt is $15,500.

The Basics

Debt: Money owed. Companies as well as individuals can borrow money.

Debt is easy to get into and hard to get out of. Rule of thumb — long-term investments may require debt, but short-term investments should not require debt. The best examples of long-term investments are college and home ownership; these are the two main factors that determine wealth potential for minorities. Short-term investments are things, like cars, clothing, and dining out, none of which build wealth.

The best method for getting out of debt is Dave Ramsey’s snowball method. I used this method in 2009 to get out of debt in 18 months, and plan to use it again to get out of debt in about 2 years. Almost all of my debt consists of student loans. Here’s how the method works:

  • Build an emergency savings of one month of expenses. As stated in Budgeting 1.0, only 38% of Americans have emergency savings for an unexpected $500 to $1,000 event.
  • List all of your debts from smallest to largest. You’ll have more momentum this way, instead of trying to pay everything off at once. With this method, you’ll target your attack on debt by focusing on one at a time.

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  • Begin making progress
    • Make minimum payments on every debt except the smallest loan ($2,500 in the example above).
    • With the smallest loan, pay as much as possible. Squeeze the rest of your budget to make the largest payment possible.
      • Get a roommate to reduce your rent.
      • Make creative meals and don’t dine out.
      • Cancel the gym membership and work out at home.
      • Cancel cable and share a Netflix, Hulu, HBOGo, and/or AmazonPrime account(s) with friends and family.
      • Suggest drawing names during the holiday season, instead of buying everyone a gift.
      • Find more ideas with the Budgetologist.
      • Pick up a side hustle to increase income. Use the skills that you have or want to acquire. Here are some great examples:

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To-Do’s

Invest in your long-term and short-term goals only after you’ve cleared all of your small debts (typically everything but your home and student loans). In the example, once you’ve cleared $24,000 (everything but the student loans), maybe you can plan a quick trip via car or bus somewhere cool, or attend a cheap concert. Upon completing the student loans, celebrate by doing something you really enjoy. Return from your trip and build a complete emergency fund of 6-9 months of expenses. So if your monthly expenses total $2,000/month, save at least $12,000 (and $18,000 if possible).

Measuring Your Improvement

  • Paying all of your bills on time
  • Minimizing your debt
  • Contributing to your long-term goals each month
  • Allowing for money to meet some of your short-term goals 3-4 times a year

Debt can be a huge burden, but it does not have to be. Getting rid of your debt can play a part in building wealth. Additionally, you can think with a clear head when you have little/no debt. Examples include evaluating your career and making life changes most easily. You no longer feel obligated to work at a job that you hate, or can think about starting that business that you’ve always dreamed of. Typically, you can pay off most of your debt in less than 2 years with this method.

Reach out to me at TheLucesco@gmail.com if you have more specific questions. Happy to share information on how to build a budget and kill your debt.

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2 thoughts on “Debt 1.0

    • The goal is to make monthly payments on everything except the smallest debt; on the smallest debt, you should pay the most possible. Any ‘extra’ money that you have at the end of the month should go towards the smallest debt. From a math perspective, your method is correct. However, would you rather have 2 or 3 debts a years later, or the same 4. Personal finance is incredibly behaviorally driven. Those short-term rewards/successes of finishing a debt are HUGELY important, as you look to see the light at the end of a long tunnel.

      In the example I provided, let’s add some annual interest rates:
      $2,500 in personal loans (5%)
      $9,000 in car loans (4%)
      $12,500 in credit cards (20%)
      $50,000 in student loans (8%)

      And after you pay all of your bills and minimum debt payments, let’s say you have an ‘extra’ $1,000 left over. Based on my recommendation, if you use the snowball method, here’s the pay off schedule:

      Personal loan: finish in ~2 months
      Car loan: finish in ~10 months
      Credit card: finish in ~23 months
      Student loan: sometime in year 4 (after 48 months)

      In the first two years, you’d go from 4 debts to 1 debt. It’s much easier to focus on the 1 than 4. And you’ll feel good about have a no credit card debt, a paid off car, and no outstanding personal loan.

      Under your method, it will take over 2 years to finish the personal and car loans.

      Drop me a line @ TheLucesco@gmail.com if you have more specific questions. Does this help?

      Like

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