Budget Opening Up
Posted by jefferson on Dec 5, 2012 in Eliminating Debt | 52 comments
When we first started this blog back in January, we were in quite the financial pickle. We owed a lot of money to a lot of different places, and the amount of money that was going to interest each month was quite depressing. There are two main strategies that the financial gurus tend to recommend when families find themselves buried in consumer debt.
The Dave Ramsey recommended approach entails starting with your smallest debt, regardless of interest rates, and pay that one off first. This means that you pay the minimum required on all of your other debts, but throw as much as you can at the smallest total. Ramsey’s reasoning is that the feeling of zeroing out a balance is major positive reinforcement to your efforts. By starting on the smallest debt total first, you are ensuring that you get that reinforcement sooner than later, which will help keep you motivated in working towards your overall goals. I can certainly vouch for the notion that it seeing a zero balance on your statement can be extremely motivating.
The alternate approach is to examine the amount of interest that you are paying to each of your accounts, and attack the highest rates first. Interest charges get added on the top of your debt total each month, and if your balances are high– they can make it almost impossible to gain any traction towards getting out of debt. By making the highest rates your top priority, you eliminate as much interest as possible from your monthly budgets. Taking this approach can help facilitate an escape from the treadmill of making payments but not seeing much progress.
While we have successfully incorporated some Dave Ramsey ideas in our journey out of debt, we mainly used the second approach. The result of this is that for the past three months, we haven’t actually paid any interest on our debt. We still have debt to pay off, but all that we have remaining is at zero percent interest, and all with a single creditor. As we have watched our balances zero out, one by one, the amount of cash that we have on hand to pay towards other debts is greater and greater. The result of this is that lately we have been able to allocate over a thousand dollars a month to pay down our debt, which actually has us slightly ahead of our debt payoff goals.
This general approach is referred to by Dave Ramsey as the “debt snowball”, but it really happens no matter which method you choose to utilize. As the number of debts (and thus, the number of required payments) decreases, the amount of free money that you have available to you starts increasing. As long as you have *any* debt, the smart thing to do at this point is to gradually increase your payments to your other debts with this extra money. Once your debt is gone, you will truly experience what it is like to see your budget opened up. In our scenario, the thousand dollars that we have in our budget right now to apply towards our last remaining balance each month, will be ours to do with as we please in the not-too-distant future.
Thankfully, my wife and I have learned a thing or two from our experiences in 2012. We don’t plan to take this extra money and buy ourselves a myriad of new tech gadgets or fancy new designer clothes each month. Instead, we will use this opportunity to fully fund our retirement accounts, increase the flow of cash into our children’s college funds, and to start saving for the home improvements and vacations that we have been fantasizing about all year. Seeing that extra money in our account today, is really merely a sneak preview of our future financial reality.
The most important take away here is the need to have a unified strategy towards tackling your debt. Simply paying the minimum each month is a rat race where few can escape. If you try running your numbers through a debt repayment calculator, you will find that paying the minimum will take years and years, and thousands of dollars in interest payments to finally get rid of your debt. Contrarily, by implementing a clear game plan and working to make changes in both your budget and your attitude towards money, you can escape the cycle. By reading blogs like this one, taking a hard look at your finances, and making a plan to get rid of your own debt for once and all, you are taking an important step in the right direction. Many have been able to take the right steps to get rid of their debt all on their your own, others have needed to reach out to a counseling organization like Debt.ca, but the important thing is that you find a way to live without the weight of debt dragging you down. After just 11 months, we are almost free of the debt cycle, and I know that you can get there too!
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We are working on paying off the highest rates first. Some of my student loans are at 6.8%!
Michelle recently posted..Should You Get An Internship?
Ha that’s nothing for a student loan Michelle. My girlfriend has a variable student loan at 8.125%! I’m just glad we don’t have the 10-20%+ credit cards to deal with.
Lance @ Money Life and More recently posted..5 Affordable Home Makeover Project Ideas
Those are high interest rates on student loans for sure.. I am thankful to have my college paid off at this point.. Altho we are saving for our kids!
Congrats at almost being at the finish line with your debt repayment!!!!
Mackenzie recently posted..My Own Grocery Challenge
We are so close that we can almost taste it!
At one time, we paid off our credit card debts using the higher interest first method. These days, we’re enrolled in a debt management plan since we didn’t have any extra room in the budget to pay more into our credit card debt. Since being in the DMP plan, we’ve noticed a dramatic drop in our balances since our interest rates have been reduced and more of our money is going toward principal instead of interest. I would caution that a DMP isn’t for everyone. We selected it as an option because we had no plans on ever using those credit cards as crutches ever again. Since that was our case, a DMP made sense because those accounts would be closed off to us anyway.
Lauren recently posted..Great Gift Idea for Kids: Under $10!
There is nothing wrong with any of this, Lauren.. Many people need a DMP, and that is just the way it goes.. The important thing is that you took the steps to start getting your life in order..
Nothing better than “paying yourself” after working your way out of debt. We definitely struggled with not going out and immediately indulging ourselves after so many months of living so frugally. So the golf clubs and non-IKEA furniture can wait while we start pumping money into smarter, albeit more boring, investments.
Johnny @ Our Freaking Budget recently posted..Feline Finances: The Cost of a Cat
Hah.. Great point, Johnny.. It will be hard to resist.. I will admit, that we created a “list” at one point of things that we want to spend money on when we are debt free.. It includes everything from a new keyboard for our laptop, to some curtains for our bedroom, to a board game that we saw that looks fun.. These things were deemed “not necessities” and we decided to wait on them..
I know we can get there too – Paying down debt is so ‘unsexy’ that it’s difficult to make the first few steps!
I’ll be ecstatic when I finally pay off my student loan!
Jon recently posted..Free alternatives to cable TV
I think paying down debt is very sexy!
Awesome job, guys! You are only a few months away from total debt payoff, right?
Holly@ClubThrifty recently posted..How Much Money Is Enough?
Getting closer and closer.. Click on the “debt progress” link at the top of the page.
Glad to know that you guys are really seeing the light at the end of the tunnel on this. Think of how much easier it’s going to be putting money away for your kids’ educations without debt!
Mrs. Pop @ Planting Our Pennies recently posted..He Said, She Said – Buying A $2K Amp
Without a doubt, Mrs. Pop.. We can’t wait.
Congrats on being so close to your goal! Hang in there. I am also working on paying my debt off based on interest rate. My highest rates are my student loans so I focus on those. It does feel odd to not be focusing on my car loan since that is considered “bad” debt, but my rate is so much lower that I barely count it.
Blair@LifeDollarsandSense recently posted..Fight to Freedom Report-November
I think you are doing it the right way.. Regardless of what is considered “bad” or “good” debt… Saving yourself interest charges is always worthwhile.
It is great to see the progress. The second method is sometimes referred to as the “debt avalanche” approach. It will save you more money in the long run and it actually the mathematically correct way to pay off debt. The snowball is useful if you cannot take control and you need the little victories. I am glad that you took a hybrid approach, but were still able to succeed. That is awesome. I used the avalanche approach with mine and am credit card debt free now. It feels great!
Grayson @ Debt Roundup recently posted..Students: How to Finish College with No Debt
I agree, Grayson.. I am a big numbers guy, and the avalanche method is what makes the most sense for me.. And yes, it has been working great!
For Our first attempt at paying off debt we used Dave Ramsey’s method. We had two 0% offers and paid those off. As our last debt was being paid off an emergency struck us and we had to start over. Now we have the same 12% card. I wish we had been smart and started with the higher interest rate card. We would’ve saved enough money in interest to pay off one of the 0% cards.
Thinking before you act is key. I’ve learned to never just blindly follow a plan.
Justin@TheFrugalPath recently posted..Co-signing: A Path Best Avoided
Did you not have an emergency fund at the time, Justin?… I truly beleive that the e-Fund is the biggest weapon to keep you from slipping back into debt.
I’m so stoked to hear that you’re close to paying everything off! And congratulations on not paying any interest!
Cassie recently posted..So… I’m keeping my beater
It feels awesome to not pay any interest.. The number that we see in our balance
You guys are doing amazing! How nice to have only 0% debt remaining.
Pauline recently posted..How to negotiate your bills and your debt
I love having only the 0%.. We have until April before we start getting charged interest on that offer.. Which might have something to do with why our goals are where they are.. Luckily, if somehow we slip and don’t make it, discover still doesn’t charge “back interest”.
Congrats on all your success in paying down your debt!
DC @ Young Adult Money recently posted..Resale Value and other Considerations When Buying a Home
Thanks DC!.. We are almost there..
Awesome that you’re nearly there! I remember that feeling and it was such a huge weight off my shoulders. We took the second route as well as to avoid as much interest as possible.
John S @ Frugal Rules recently posted..November Blog Goals Update
Every month, the backpack on our shoulders get a little bit lighter, that is for sure..
Yayyyy! Congrats!
L Bee and the Money Tree recently posted..Monthly Goals Update-See how I did for November
I think its a very good idea to use the second method as well. Rather than letting interest cause you to pay extra money on loans, its smarter to pay the debts with most interest down so you’re not adding more money to what you’ve paid in the long run. Congrats on being ahead of schedule on debt repayments, all of the information here is important and useful.
Kelly@Financial-Lessons recently posted..How to Make Your Videos go Viral
Thanks for the kind word again, Kelly!!!
Congrats for you guys! We’re also working hard to pay everything off as fast as possible. When I go back to work in May from my Mat leave I’m really hoping we can continue on the way we have been and throw my extra income at the debt rather than being tempted by the increase in our monthly budget. I’m hopeful that we’re mastering some pretty fine budgeting skills though and we’ve both learned to be on the same page. We’ve come a LONG way in terms of our communication about money in the last few months. Congrats for you guys
Catherine recently posted..Money That Would Have Changed My Life.
We have too, Catherine.. Our inter-marriage communication about money is more open than it has ever been, which has us completely aligned towards our debt payoff goals.
Great work Jefferson!
Getting those small wins by paying the smallest pile first is the track my wife and I are on so we stay motivated.
It’s definitely a mindset thing, getting out of CC debt but then staying out of debt by learning to use CC’s correctly (because the bonuses you get are good!)…we’re learning the hard way
Great work!
Joe Cassandra recently posted..What Mindset do you have to Get Rid of Your Credit Card Debt?
Thanks Joe!.. Those small wins do certainly help along the way.. I am pretty happy with the way things look these days when I start sifting through my finances.. (considering where we have come from).
Congrats on your amazing journey. It’s been a lot of fun to read about your progress and get to know you (semi-personally). I’ve pretty much followed the Dave Ramsey approach to the debt snowball, however, when we get our next (smallest) student loan knocked out, we’ll likely focus on the 2nd method you suggested. For us there was simply too large of a different between our smallest debt and the remainder not to try and knock that one out first as it will take nearly 12 months longer if we approached the other route.
WorkSaveLive recently posted..What to Get Your Husband for Christmas – Ideas for Every Budget
Thanks for the super nice comment, Jason! We have really enjoyed sharing the journey and getting to know everyone in the PF community.
I think that many folks employ a hybrid version of the two approaches, generally attacking the higher interest debts, but knocking out debts completely when you have the opportunity.
I have learned the hard way that paying just your interest is such a waste. Keep pushing towards your goals!
Budget and the Beach recently posted..Big Things Await
Without a doubt, Tonya.. My goal is to never pay interest again (except the house)..
You’re doing awesome and sharing everything openly with people is really good for them, too. Let’s them know that they really aren’t alone!
Thank you for your blog.
Heather
Heather recently posted..Night Owls and Early Birds
Thanks again for the kind words, Heather.. Sharing this journey has kept us accountable, and kept us motivated and on track. I would recommend this as a tool for anyone..
Nice work! We used Ramsey’s alternate method to pay off student loans and that snowball plowed through $30k of debt in 9 months. It definitely works!
Jessica @ Budget for Health recently posted..How much does obesity cost?
Ramsey has helped tens of thousands of people with his no nonsense approach and his general methodologies.. I think that his idea of the Emergency Fund is the biggest winner of them all..
Congratulations! You have come so far within a year. Both approaches have merit, but I think what matters most – as your story clearly demonstrates – is finding which approach motivates you to save. Soon you’ll be on your dream vacation that you’ve worked so hard to earn!
Shannon @ The Heavy Purse recently posted..My Favorite Childhood Christmas Traditions
Aww yeah.. I can’t wait for that reward vacation.. The beach sounds especially nice on these cold winter nights..
I agree that paying down the highest interest rates first makes more sense. And snowballing helps accomplish the goals faster!
Christa recently posted..Kids’ Christmas Gifts on Less
Agree Christa.. I think that I am allergic to interest payments.
I love these updates, Jeff! You’re doing such a good job! I think I’m going to have more debt before I pay things off, but I’m okay with that — a girl’s gotta live somewhere, right?
Kathleen, Frugal Portland recently posted..How Decluttering is Like Getting Multiple Tattoos
Yeah… I dont think it is realistic to expect folks to be able to pay for their homes with cash.. And with mortgage rates where they are, the rates are not prohibitive.
Way to go, before you know it all that debt will be behind you. Keep at it! Mr.CBB
Canadianbudgetbinder recently posted..Bank Sales In Canada ….. Not The Same As Bank Foreclosures In The U.S.A
Thanks for the support, CBB!.. We are getting closer and closer.