Category Archives: Debt

-$114,000 Net Worth: Creating a Plan to Get Out of Debt

creating a plan to get out of debtA friend of mine, “Doug,” came to me last week asking for some financial advice. He lives in New York City, has a stable job at a fortune 500 company paying $60,000/year, and we have very similar educational backgrounds. Except that he has $117,000 in student loan debt, $1,300 in credit card debt (maxed out the credit card and is paying 13.99% APR), and a 5 year old $4,000 debt that is in collections. Oh, and -$23 in his checking account!

It sounds a bit crazy, but that’s exactly why Doug came to me asking for some help. He’s exhausted all resources and while his parents have helped him get by, this actually may be holding him back from getting his finance in order rather than helping. In asking for my help, he agreed to (and actually recommended) using this on the site as a project.

Where His Money Goes

I took a quick look at his Mint account to get a good snapshot of where his money is going. The first step is taking inventory and finding out what’s happening now; later we’ll look at how to improve. His rent is $1,000/month, which is fairy reasonable for where he lives in Manhattan. And Doug iss smart enough to have a couple of roommates. But he has a lot of “random” expenses like cab rides and travel that significantly takes up his hard-earned money. He’s a mid-20s guy living it up in New York and hasn’t taken the time to get his financial life in order. But hopefully that will change soon.

Critiquing His Spending

The thing that stuck out most to me was that Doug spent $748 at restaurants, $185 on groceries, and another $106 on fast food. That’s $1,039 spent on food alone (not including alcohol and bars)! For reference, Lauren and I spend about $700/month on food, with about $100 of that being spent at restaurants). None of this is included in the $480 of cash/uncategorized transactions in the month. Finally, there are $51 in ATM fees/finance charges that could be simply avoided. That’s not preventing him from being in a good financial position, but it’s indicative of his general ideas about money: do what I want now and I’ll figure the rest out later.

spending too much on food

Creating A Plan

After getting over my initial shock, we discussed a plan going forward. The immediate need was to pay off the credit card bill to avoid the high interest and build a cushion in his checking account. Then we’d tackle the collections account and start some more future planning. How would we achieve this? We’d make just a couple of tweaks that would have a tremendous effect on his finances.

First, Doug agreed to eat out at most once a day. Previously, he was eating 2 meals out every day. And when you’re ordering $12 Chipotle multiple times a day, it makes it really hard to get by and save. Instead of $1,000+ a month, we reduced his monthly food budget to $500, which is completely doable and I’ve already seen him put the changes into practice.

Next, we reduced his 401(k) combined Roth and traditional contributions from 15% of his salary to 4%, enough to get the 2% match at his company. And that drop in contribution leads to over $550/month in after-tax earnings that he’ll be able to use to tackle his debt in the short-term.

One thing I made him do was call his bank and request that his recent $35 insufficient funds fee be credited back to his account. He told them it was a one-time thing, and they removed the fee for him. That was a very easy win, and it showed him that while it will take a significant amount of time to get into positive net worth territory, the immediate changes he was going to put into effect would have a positive impact.

Future Financial Plans

Looking down the road, once the immediate needs are taken care of (we project the credit card will be paid off in October), we’ll look to settle the collections account. And of course, pay down the student loans. It will certainly take time, but the interest rates on those loans are fairly low, in the 3-5% range.

This plan is not foolproof. Doug must be serious about changing his lifestyle and seriously cut back on his spending. He can’t continue to spend on taxi cabs, eating out daily, and unnecessary fees. The good news is that he is young enough that time is on his side and he won’t be saddled by debt forever if he gets his act together. It will be an interesting journey, and hopefully your encouragement will help give him the motivation to stay on track and turn his situation into one of having just about nothing to one where he is in control of his financial future.

Would You Gain 25 Pounds To Get Rid Of Your Debt?

Appearances matter, but how important are they to you?

If you were given the opportunity to get rid of all your debt but have to gain 25 pounds, would you take it? Or would you keep your current debt and stay the same weight?

A recent study by Credit Karma showed that 72% of respondents would rather keep their current debt than gain 25 pounds and be completely debt free.

That may sound like a high percentage to some people, but let’s break this down a little more:

  • In almost all cases, we earned the debt. It seems like cheating to get rid of all the debt, so maybe there is some guilt involved with getting rid of it all at once.
  • 25 pounds is a lot of weight. It can be pretty life-changing and it happening all at once can be a lot to deal with.
  • Nobody sees your debt balance but everyone sees your weight.
  • We have no idea how much debt the people who were polled are in. Maybe it’s not that much?

Lauren and I have about $50,000 in student loans left. While I would love to get rid of it, would I be willing to gain 25 pounds to get rid of it? I don’t think so. That would change my life in a few ways:

  • I wouldn’t be able to run as fast and that would affect my performance while playing basketball, something I really enjoy doing. Straight up, I would be worse
  • I’d never look good in anything I wore and would have to get a completely new wardrobe.
  • My wife would definitely be less attracted to me.

If I could lose the weight quickly, then yes, I’d be inclined to do it. But I don’t think that I deserve to have the debt forgiven, even if I have to pay the price of added weight. The reality I live with isn’t so bad now, so why change it? The risk of changing my way of life might be worse than the debt we currently have.

I posed this question to Lauren, who is smarter than I am, and this is how she responded:

Of course I would gain the 25 pounds to get rid of the debt. Then I’d hire a personal trainer to lose the weight.

While this isn’t a perfect study and isn’t representative of Americans (it was an online study that wasn’t truly random), it does provide an inside look to how many people think.

If you were given the choice, what would you do?

Information for individuals with large amounts of student loan debt: http://www.simpletuition.com/student-loan-consolidation/

Do You Make Monthly Payments or Lump Sum Payments?

Many personal finance bloggers encourage readers to set up automatic monthly payments. This results in fewer missed payments, fees, and maybe most important, it ensures that we’re making progress on our debt payments. If we commit to paying extra on our student loans, an automatic payment is great because it happens without us being actively involved, so we are less likely to miss that money.

This year, we’ve been doing the exact opposite. Since January, we’ve made student loan payments of $7,000, $16,000, and $10,000. We’ve also contributed 4 payments of $5,000 to our Roth IRAs and my individual 401(k) accounts. That’s a lot of lump sum payments!

Our monthly bills like rent utilities are automated, but our retirement and debt repayments are not.

Why We Make Lump Sum Payments

I’ve gone through a ton of life events over the past year, which has made automating our bills seem like a bad idea: I am paid a salary but most of my compensation from work comes from commission, so scheduling payments monthly doesn’t make much sense.

I also am running a small business with blogging and other online ventures, so projecting my income is even more difficult. The amount I’m allowed to contribute depends on how much I make, so every time I hit a big milestone in income, I contribute more to our retirement accounts.

Why do we let our checking and saving accounts get so big before making payments? Part of it has been because we’ve been lazy, but a big part of it is because parting with our money is difficult. We worked hard for it and now we have to give it away?

Readers, do you make monthly payments towards your debt and retirement accounts or do you wait and make large payments?