YNAB Podcast Episode 57: When debt is an addiction.

Hello YNABers. My name is Jesse Mecham and this is podcast number 57 for You Need A Budget, where we teach you four rules to help you stop living pay check to pay check, get out of debt and save more money.

Today we are going to be interviewing a participant in an awesome program, proven program, to help people that have a debt addiction, and that is Debtors Anonymous. I found it terribly interesting to interview Linda and to find out how the program worked; and she is an excited YNABer and she spreads the YNAB word among her Debtors Anonymous aficionados. So, it’s a great program.

Without further ado, here is the interview:

J: Okay, this is Jesse and I’m here with Linda I – that is not her real name, but she’s a member of Debtors Anonymous, and I just wanted to have Linda speak with us about the program and how YNAB helps in that, but also maybe how people would know if they should look into it. So, Linda, let’s just dive right in. Well, first, let me thank you for being on the program.

L: Thank you, Jesse.

J: This will be a lot of fun. I wanted to basically dive right in and just ask you if there’s a point where someone should be concerned that they really… I mean, we know debt is a problem for many, many people, but when someone should be concerned that they REALLY have a debt problem; like what kind of signs to be aware of.

L: Well actually, the organization Debtors Anonymous has 15 questions to ask yourself that can give you a clue if you’re really in trouble, such as, “Do your debts cause you to think less of yourself? Have you given false information in order to obtain credit? Do you make unrealistic promises to your creditors?” So if you read those, they say if you answer yes to at least 8 of the 15 you really should look at yourself and consider it that possibly you’re a compulsive debtor. There’s also signs of compulsive debting. The Debtors Anonymous site is debtorsanonymous.org, and it just talks about compulsive shopping and describes a lot of different signs that you can tell if… You know, so if you’re borrowing money off one credit card to pay another credit card, or if you just don’t pay your bills, even if you have the money you just can’t find the bills so you accrue late fees – all those things are signs that there’s something wrong and your life is unmanageable because your debt is just becoming crushing. If you look at it and you’re just constantly using credit cards or you can’t stop shopping even though you want to… You know, I know people who have plenty of money but they are out of control with their spending, even though they have the money. So it’s not necessarily that you don’t have any more money or you just have a lot of debt; and they say a compulsive spender is just a debtor who hasn’t run out of money yet.

J: Okay. So there’s obvious financial strain there with compulsive spending. Someone that maybe recognizes that they have a problem, they want to stop, how does that compulsive spending affect the person’s life outside of the obvious financial… direct financial consequences?

L: Well, I found just from my years now of being in recovery compared to being out there, it destroys relationships. I mean, I think – you might know this – there’s a huge number of divorces that occur over finances. You know, when one of the partners is a compulsive spender and one of the people is responsible, it can just wreak havoc because the person who’s out of control is spending money that maybe is needed for the mortgage or for food. Another thing, it can affect your relationship even with children. Let’s say you have small children but you’re compulsively on the computer with the home shopping network, not paying attention to your children. It can affect your time; they talk about time debting where you just… you fritter away and waste time with compulsive spending and compulsively thinking about spending.

J: Absolutely. So it’s interesting, when they were… I remember speaking with someone and I said, “Well, how do you know when you’re addicted to anything?” and they said, “Well, as soon as it starts to affect other aspects of your life – your job, your relationships, your health, things like that – then you know that you’re addicted,” and that goes for alcohol or gambling or any other number of vices, so to speak.

L: Right. This is not a play illness, you know; this is a very, very serious thing and people, they kill themselves over this. I mean, it destroys lives. It’s not a joke. And I think anybody who’s experienced the weight of crushing debt or not being able to stop spending money and worrying about using money that should be used for something else but they just can’t help themselves can understand that this is devastating.

J: Tell me about the structure of the Debtors Anonymous program – how it works, what the benefits are for those that are seeking help through the program, and maybe the difference of them going the Debtors Anonymous route versus tackling it on their own.

L: Well, the Debtors Anonymous route talks about… First of all, you aren’t alone – that’s one of the wonderful things, is that somebody who also has that problem can really help somebody else who has the same problem, right, because you can identify it. There are meetings; there’s many, many meetings on phone, so people all over the world – it’s just amazing – can get on the phone and all talk about the problem and the solution. And they say the solution is a spiritual solution, but that doesn’t mean religious because it is a big difference. But it’s if we could have stopped on our own, I think people who really have a problem with being out of control with money and debt would do it. I couldn’t do it on my own.

So, the program is based on Alcoholics Anonymous, and there are 12 steps and those are kind of instructions. There are books that you read and… So people go to meetings, and there are face-to-face meetings but they do it on the phone as well. One of the key things is a spending plan, which is where YNAB comes in, because without… They don’t call it a budget, even though you call yours a budget – that’s sort of a “no-no” word in Debtors Anonymous because budgets can imply deprivation, like being on a starvation diet; whereas Debtors Anonymous is helping you create a spending plan which is showing you how to use money to live your life appropriately. As opposed to gobbling a whole cake, you know, eating it in proper bites. So, in Debtors Anonymous, by having a spending plan – which YNAB is THE perfect tool… In the older days people did what was called the envelope system where they literally kept cash in envelopes that were labeled Groceries and Hair-cut; and YNAB is a virtual envelope system. It’s just… it is THE most perfect tool, because it helps you accrue in your different categories so you save up for things monthly. And one of the best ways to do that spending plan is to take what you have to pay and you divide it up by, let’s say every month you owe your car payment, so you put that much away, or if there’s an annual… something you pay annually you divide it by 12 and for each month. I mean, I know this is all the stuff you teach as well! And you also get someone called a sponsor, who is another member who can help you on the phone.

Now, I do something called the HOW Program – Honesty, Open-minded and Willing. It’s a little more structured with the tools. So, I make a phone call every day to a sponsor; I tell the sponsor what I planned to spend yesterday to the penny, what I actually spent to the penny, what I plan to spend today; and I actually don’t spend one cent without calling somebody or texting somebody to let them know, and it is the most freeing thing in the world. So I no longer compulsively just go have a spending binge. And I also do some writing and reading every day – not excessive, just something that kind of helps me to think about the healing part of this. And we also call each other in between to get support. And one last thing, we do something called Pressure Relief Groups. That’s where two other members get together, say with me, and I do it on the phone, and they help me with any financial pressures, to work through my spending plan, to create the spending plan, to tweak it to if I need to save for something or if a crisis comes up. It’s just, it’s a wonderful way to support each other and to gain the strength together with others to do what we couldn’t do by ourselves. So that’s pretty much it.

J: So you combine… I sometimes wish that I could have YNAB sponsors; with everyone that purchases the software, I wish they could call someone and say, “Okay, tell me how this works.” We try and do that with our online classes to a degree, but I’ve always wanted that sponsor program. It’s always been so fascinating to me because it just seems so effective. You know, someone that has some empathy for that person’s situation, having been there and kind of walked that same path.

L: Well, that’s why I just created a website called gettingoutfromgoingunder.wordpress.com, and that’s the purpose. I wanted to talk about… That’s why I’m doing it anonymously because in the program you can’t reveal your name, etc. But I wanted a place where people who were maybe exploring this program, or even not, to understand how to use YNAB in context of the program. So for instance, today I just wrote a posting about split transactions and how to do them, and with some philosophical ideas around it. And I have some posts on setting up the spending plan within the context of the whole DA ideology.

J: This is great. So, for people that maybe… you know, maybe they’re not compulsive spenders, maybe they aren’t a prime candidate for Debtors Anonymous, but what are some good habits that people can maintain to make sure that their debting never becomes a serious issue?

L: Well, actually, something that shockingly my own son is doing on his own – he’s in college and he called me, he was all excited – he’s using a tool to write down every single thing he spends. And so he said, “Do you know, I spend most of my money on pizza!” You know, it was kind of funny! And I think the most… to me, the key thing is being… having clarity about what you’re spending your money on. I think everybody should use YNAB – I do, whether you have this problem or not – because you get… there is no more clarity than with your program. And I mean, you’re not paying me to say this! I’ve used your program for almost three years now, and it has just changed my life. I was an expert Excel… I could do Excel spreadsheets and all kinds of stuff, and before YNAB I just couldn’t get it right; I just kept, “No, but I need this and I need this and I need this.” And then when I got YNAB, you actually had everything that I felt that I needed.

So to me, the willingness to live by the categories, to reconcile with your bank account; I’m surprised at how many people don’t know how to do that. I just did a post because a couple of people were telling me they’d never done it before, and I was shocked. These are adults! You know, these are not just kids. So I think, I really think that being willing to live within your means is crucial, especially in these days. My husband is not a compulsive spender or debtor, and I’ve watched… he’s amazing. He, of his own volition, writes down every single thing he spends; he’s never had credit, other than he’s had a mortgage or a car payment; but if he uses a credit card he pays the entire thing at the beginning of the month. He’s never been in debt. And I think that’s the most important thing that people can do, is live within their means. I mean, just as a person. And that’s separate from the 12 steps, which is what somebody with higher power and power that’s greater than you in your life – that’s a little bit different.

J: That sounds… It really comes down to what we talk about a lot when we talk about Rule One, and just one word to sum up the idea of giving every dollar a job; and the idea is just to be aware. You know, just to have awareness; just to know where the money’s going and making sure that it’s doing things that you really care about.

L: Right. And you might find that, you know, if you’re short at the end of the month and you say, “Oh my God, I go to restaurants so much!” how much clarity that gives you. And you can change that behavior. And the other thing is… you call it the buffer, I call it living in the next month. That absolutely is the most amazing thing, and it’s not so easy to get to. But the idea of “what I earn this month I spend next month” is SO freeing, because on October 1st I don’t have to worry about that in the middle of the month… I know I’m getting a check on the 17th but today I’m almost out of money, I know on the 1st exactly what I have to spend for the whole month. It’s just the most fabulous thing, especially… well, for anybody who gets maybe two pay checks a month. Right? So on the 1st they have their pay check, but their spending plan is for the whole month; however they’re not going to maybe have enough on the 14th if that check hasn’t come, the second check.

J: It’s just a lot of stress there. That timing of those bills to pay checks is just lots of stress. Absolutely.

L: Yes. They should teach this in school!

J: They absolutely should. You know, the only problem with that is that the kids don’t have any pain yet. That’s what I always tell people. I say, “Well, if the kids had bills to pay then they’d start to feel that pain; but they don’t so they don’t perk up because they don’t have a pain to talk about.” But it is something that we… I mean, as parents, you know, you basically teach your kids by example, and it’s kind of like you do things so loudly I can’t hear what you’re saying, is kind of the phrase. And so I always hope that I can LIVE in a way that my kids can just see, “Oh yes, dad checks his budget before he spends money, and then he plans,” and things like that. So that’s probably the biggest thing. But that means we have an awful lot of adults to educate in the meantime.

L: That’s true. And I just want to make sure, because I think I just [?? 0:15:14] this off, but it’s really important to know that the 12 step programs – all of them – really have a basis in a spiritual kind of recovery and believing that you are not the power of everything; you’re not in control of everything, that you’re powerless and that there is a bigger power. So it’s not religious, but that is the crucial concept where it works. And we do help each other, but the biggest concept is that there’s something outside of us that can help us.

J: And it’s proven to be effective for how many… I mean, how many people have gone through it, any of those 12 step programs?

L: Oh, just millions and millions. And right now I have over three years of continuous abstinence, meaning that I have not debted, not incurred any new debt. My debt was at $33,000 and now it’s down to about $14,000 in this time; and I’ve been able to save money. So it’s really miraculous.

J: That is awesome. Well, Linda, thanks so, so much for coming on and sharing with us. I’m confident that there are people listening to the podcast that this applies to, and that they know people to whom this also applies, and so I love that you can get the word out. So your website – gettingoutfromgoingunder.wordpress.com – where people can read a lot more of what you’re writing, and probably find out a lot more about your story and things like that, and how you’re using YNAB as well.

L: Yes. But the Debtors Anonymous site, which is the real… My site is just my own; it’s not approved by them or anything; that’s not conference-approved. That website for Debtors Anonymous is debtorsanonymous.org.

J: Okay, awesome. Well, everyone knows where to go to get more information. Thanks so much, and you have a great rest of the week. And yes, good luck in your continued budgeting efforts.

L: Okay, take care.

J: Bye bye, Linda.

Until next time, follow YNAB’s four rules and you will win financially. You have not budgeted like this.

Don’t let the debt get you down

ostrichHi – jessiebird here again. The other day I came across an old debt payoff chart I had made. It listed all of our debts at the time, with balances, minimum payments, interest rates and a grand total. The five debts — including a credit card on which we owed over $10,000 —  came to a demoralizing $45,162.39.

The chart was dated Aug. 22, 2012.

That’s an important date. It’s not when we started with YNAB; that was July 2011. It was, instead, the first time I had been brave enough to write all of our debts down in one place — and that’s after we had already paid several off.

If you’re a natural-born number-cruncher who doesn’t feel like hiding under your desk every time you think about your staggering debt load, you might wonder how I could have waited so long. Well, when we first came to YNAB, I thought we’d never get out of debt. Seeing the total on paper would have confirmed what I already felt, that I was a complete financial failure. So I waited until we had paid down enough that I started to believe that maybe, just possibly, we could actually get a handle on the debt.

On the off chance there are few of you reading this who are where I was then, feeling hopeless under the weight of your own soul-crushing debt, I offer the following advice:

  1. Crawl out from under your desk; you can’t accomplish anything from there (and there might be spiders). As scary as it is, gather up all of your debts so you know what you’re dealing with. Compare the balances and interest rates to figure out the snowball payoff strategy that works for you.
  2. Focus on your whole budget, not just the debt. Do budget for the debts and pay them off as aggressively as possible, but don’t forget the importance of emergency savings, fully funded categories, a buffer, and even a little fun now and then. This is a budget, not a prison sentence.
  3. Stop letting your past mistakes define you. Yes, you’re in debt. Do the only thing you can do: Deal with it in your budget. And then stop feeling so bad about it. Seriously. It’s exhausting.

Obviously, I was a little late implementing step 1 myself. But I’m doing well with steps 2 and 3. Since I wrote up that debt chart 20 months ago, we’ve paid off around $27,000 (including all of the credit card debt). In total, I estimate we’ve paid off well over $40,000 in less than three years.

And here’s something I never thought I’d be able to say: We’ve only got $18,000 left to go.

(Granted, it would be even more exciting if I could say we were debt free. But at least I’m not hiding under my desk anymore.)

Being Thrust Upon YNAB, Part Two

alex-smilingI’m going to present you with two words. Just a bunch of letters arranged on a page. Nothing inherently harmful in them. But because of the meaning we attach to them, they’re powerful enough to send an arrow of fear straight into most people’s hearts.

Foreclosure.

Bankruptcy.

Yeah. Scary stuff. These two words are what brought me back to YNAB in 2012 with a big old *snap*.

Foreclosure. The first time I heard the word from my credit counsellor’s mouth, I cried. It felt like the ultimate failure. I envisioned our furniture on the lawn and a red-lettered sign on our door for all the neighbourhood to see.

We had separated. We owned a four-bedroom house (well, the bank owned it), and even though it had a legal suite, the mortgage was enormous. Neither of us could manage it alone. Neither of us could manage the house’s upkeep. And neither of us had the heart to stay in what had until then been our family home.

But the Victoria market had softened in the four years since we’d bought. No matter what we did, the loss was going to be crippling.

We ended up foreclosing. It took us a long time to make the decision, but once it was made, I was surprised at the relief I felt. I still give thanks that we live in Canada, where you can swallow your pride, press a button marked RESET, and start all over again. There are no armed thugs waiting to exact full payment. Nobody’s going to shoot your family or sell your children for unpaid debts.

In the end, the loss was crippling. By the time the process was finished – post-inspection, post-cleaning, post-sale, post-legal fees – the shortfall on the house was $92,000.

By this time, I had bought myself version 4 of YNAB and was back on track, monitoring my income and expenditures and living on what I earned. It gave me a feeling of control during a time when so much was out of control.

I looked at that $92K, as well as the other debt (including a whole whack of federal tax – a result of the previously alluded to communication breakdown), and realized I was looking at packing around a lifetime of red ink.

As a newly single parent (and a freelance writer at that), it was a devastating load. Even if I could pay it all back over the course of fifteen or twenty years, I would be shorting my children as a result of my and my ex-spouse’s fiscal choices. Their entire upbringing would be a story of their mother being too broke to support school trips, camping, music or swimming lessons.

I agonized. Should I declare bankruptcy, file a consumer proposal, or slug it out? My ego was very much afraid: What would people think if I declared? And how would I feel about what people think?

There’s something so terminally scary about losing your credit. People speak of it in whispers. Had I not been living the YNAB way, I would likely have gone along with the pressure from my (traditional…and very much in debt) parents to do everything possible to avoid damaging my credit rating.

But my desire to provide for my kids trumped my need to look like I had it all together. I’m not a fan of sweeping it all under the rug to look like things are fine, just fine.

And, I reasoned, if I’m living the YNAB way, my credit rating shouldn’t have to be my number one concern because, well, I’m not supposed to be buying things on credit anyway.

And so I threw it in. Declared bankruptcy in mid-2012. YNAB supported me every step of the way. Even when the thumbscrews were down tight as I repaid a portion of the debt (and yes, even if you declare bankruptcy, you still pay some back), I knew how much I could spend in each and every category. I stretched every possible thing, à la Amy Dacyzyn’s Tightwad Gazette. Bars of soap down to slivers. Robes and slippers instead of heat. Noodles.

I was discharged in early 2013, and I haven’t looked back. I don’t eat out – even at Denny’s – and when I’m in the vicinity of Linens & Things I just keep driving. The new 4Runner was out-reasoned by a ten-year-old Escape (4cyl). And my entire apartment is a sunroom now, because it faces west. All one bedroom of it.

I got myself a Capital One MasterCard – it’s funny how fast they come knocking – and you bet I’m paying it in full every month. But I paid cash for my truck. For the kids’ bikes. For the Apple TV. For the dining room table. And when my poor old laptop wheezes her final stalling breath sometime this summer, I’ll have $1300 set aside in my MacBook Air category.

I love giving each dollar a job. Because damn, they work hard when a few of them get together. And I love YNAB. Because it makes this kind of little-by-little saving possible.

So now you know. I’m living proof. There is life after debt.

When you finance anything, you finance everything.

ball-and-chainUntil you’re completely debt free, everything you purchase is financed at the rate of your highest-interest debt.

What an awful (and important) thing to realize.

After Tuesday’s post about the concept of “afford” being useless,  Kate and I were discussing our desire for garage gym equipment. I asked her how she felt about the fact that paying cash for the equipment while we have debt at 10% interest is the same as swiping a 10% credit card and carrying the balance.

“That’s not right,” she said. “It’s not the same thing. We’d never put it on a credit card.”

“Right, but that’s exactly what we’re doing by buying it before our debt is paid off.”

“Well, that’s not true for essentials like groceries. It’s not like we can go without food.”

“Yes,” I told her, “it is true for groceries. Whether the purchase is essential or not is irrelevant. When you spend a dollar on something other than reducing the debt, you’ve financed that dollar. Every penny we spend is financed at our highest interest rate.”

“So, what now? You’re saying we can’t buy gym equipment until the debt is all paid off?”

“I’m just fully accepting the idea that we’d be incurring new debt by choosing not to pay down the old debt.”

“Well, we have to live. Where’s the balance?”

Where’s the balance, indeed.

The “balance”, it turns out, was wrecked when we decided to spend money we didn’t have. How interesting that we and other debtors are so comfortable getting out of balance by swiping the card or signing for the new car, but feel entitled to a “balanced” approach in how we repay the debt. We humans are funny that way.

Where does this realization leave me? I now have to consider a new, interesting, uncomfortable question every time I go to buy something:

Would I make the purchase on a credit card and carry the balance?

(Reminds me of a conversation I overheard at the gym a few weeks back. Actually I only heard one sentence:

“Yeah, we’ve decided it’s worth it to us to go ahead and put it on the credit card and pay it off over time.”

Maybe he was talking about a kidney transplant, but I don’t think so. I wanted to back-hand the guy, grip him by both shoulders and scream “Don’t do it man! Debt wrecks everything!” Maybe, after wiping the bits of spittle off his face, he’d have come to his senses. Or maybe he’d have throat-punched me.)

Anyway, back to our new, interesting, uncomfortable question. I’ll tell you what – it’s a game changer.

Would I put groceries on a credit card and carry the balance? If I had to, yes. But I’d probably have to give up my pre-cooked bacon from Costco. (Now I’m really in a terrible mood.)

I guess I’m finally realizing why people like Dave Ramsey and Mr. Money Mustache – however much those two don’t have in common – advise us to run from debt like a gazelle from a lion, and to treat it like a swarm of killer bees covering our entire bodies. It’s because, while we have debt, it casts a shadow over every purchase we make – or wish we could make. Especially that most important of all purchases: saving for the future.

The scripture tells us not to run faster than we have strength. That seems like wise advice. It doesn’t, however, tell us to avoid running. And it really doesn’t tell us to go backwards.

How to Sequence Your “Get Ahead” Dollars

bag of moneyLast week’s post on whether to pay off credit card debt or max out a 401k raised good discussion interesting questions.

It led to a YNAB office chat about how to sequence your “get ahead” dollars – a “get ahead” dollar being defined as one that either reduces the balance of a loan or recruits other dollars (ie investments).

Here’s what we came up with:

*The usual disclaimer: no part of this article is meant as investing advice. I present this information only for discussion purposes.

1. or 2. Pay off high interest debt.

If you’re carrying debt at 7% interest or above, make it your number one priority to pay it off. Trying to get ahead in your retirement accounts while you still have debt is like trying to pedal a bike with the brakes on.

The only possible exception is when your employer-matched 401k contributions give you an instant 100% ROI on those dollars. I say possible exception because it’s hard to be wrong when you make it your top priority to get rid of high interest debt.

2. or 1. Max out your tax-advantaged, employer-matched 401k contributions.

A key distinction here would be that you’re only contributing the amount necessary to receive your full employer match. Once you’re getting all the free dollars you can from the match, put your extra dollars into a Roth IRA (I’ll explain momentarily).

3. or 4. Pay off lower-interest debt.

This would include anything in the 0% to 6% range. My mortgage is at 3.99% interest. Does it make sense to prioritize it ahead of maxing out my tax-advantaged retirement accounts?

The strict math says I’ll likely earn more than 3.99% in the market than I would in an indexed mutual fund protected by a Roth IRA. On the other hand, paying off my home allows me to have a much smaller retirement nest egg.

I personally lean toward paying off my house. We’ll see if that’s still true when I’m finished with my higher-interest debts.

4. or 3. Max out Roth IRAs for yourself and your spouse.

The 401k was originally created to supply up to 20% of your pre-retirement income, but quite a few people seem to think it’s the only retirement vehicle they need.

Not only is a 401k not likely to get you through retirement on its own, a Roth IRA has features that make it more appealing than most 401k plans:

a. After you reach the qualifying age, withdrawals from a Roth IRA are tax-free.

b. You’re likely to have more control over the funds inside your Roth IRA than you would with your company-sponsored 401k. For example, Jesse had to pay an extra fee to allow YNAB team members access to Vanguard mutual funds. I don’t think many employers would do the same, which means you may not be able to access top-performing funds unless you seek them out in your own Roth IRA.

By the way, have you checked on the funds in your 401k lately?

c. There’s less hassle and overhead associated with a Roth IRA in the event you change jobs or companies.

5. or 6. Max out traditional IRAs for yourself and your spouse.

Traditional IRAs give you an up-front bonus on your saved dollars because you make contributions with pre-tax income. In other words, you don’t pay taxes on the money you put into a traditional IRA.

You will, however, pay taxes on the withdrawals you make after reaching a qualifying age. That’s why – other things being equal – we prefer Roth IRAs. They offer the same investment opportunity (currently capped at $6,000 per year, per person) while also offering tax-free retirement income.

6. or 5. Max out Health Savings Accounts for you and your spouse.

Health Savings Accounts are the only financial/investing instrument that allows you to make pre-tax contributions and withdraw the money tax free.

You can also use the money as-needed to cover qualifying medical expenses. In other words, HSAs are great tools.

7. Having maxed out all your tax-advantaged savings vehicles, save any extra money in taxable investments.

How’d we do? Do you sequence your “get ahead” dollars differently?

For a more detailed discussion of saving and investing, check out Jesse’s (YNAB founder) 9 Day Investing Course.

Should I pay off my credit cards or max out my 401k?

questionIn the unending “pay off debt first or start investing” debate, I’ve learned about a small wrinkle:

If your employer matches your 401k contributions, you earn an instant 100% bonus on every one of those dollars. In the worst of scenarios, your credit card company is charging you interest in the high 20s.

The Big Disclaimer: None of this is intended as advice, nor should anyone reading make large life decisions based on this content or subsequent discussion. I’m just starting a conversation here; each person should evaluate his/her own unique needs and circumstances before making any important financial decision.

In other words, in cases where you haven’t reached your maximum employer match, the math tells you to prioritize 401k contributions ahead of paying off high interest credit card debt. Once you’re getting every matched dollar you can from your employer, the math says to throw the next dollar at your credit card debt.

That’s the strict math, but what might change the equation and tip the scales back toward a full focus on the credit card debt?

If a person can’t make the required 401k contribution and keep all bills paid and debts current – the math doesn’t matter. He can’t afford to “buy” the matched dollar from his employer.

If that same person is pushing every extra penny to credit card debt, and views the freed up credit card availability as his “emergency fund,” redirecting the money to his 401k for the sake of the match could create excess risk in his finances.

Sure, he could borrow the money back out of his 401k, but that carries its own risk:

  • He loses investment growth on the dollars borrowed from the 401k.
  • The loan has to be paid back with post-tax dollars (which means the payments will reduce his take-home pay).
  • If he leaves his current job, the full 401k loan could be due within 60 days, creating a situation where he still has the credit card debt, still has no emergency fund, and now has to come up with the money to pay off the 401k loan.

Although I don’t have any credit card debt, here’s how I would approach this problem:

If I were snowballing credit cards with extra money, I’d prioritize matched 401k contributions ahead of paying off debt. You just can’t beat an instant 100% ROI.

But, I’m working on the major assumption that the hypothetical borrower has broken the borrowing habit – maybe even closed/cut up the credit cards – before heading down this path.

This is all on my mind because I recently had a friend go through this process. He was snowballing his credit card debt and realized he was leaving money on the table by NOT getting his full match. He reallocated snowball money to get the full match, then did a consolidation loan through Lending Club to pay off his credit cards (and get a much lower interest rate). For him, it’s a big win in terms of interest NOT paid and interest earned.

When You Make Gains in Your Budget, Lock Them Down

keysI’m supposed to be rolling this big debt snowball, right? Hating my debt, fighting to be rid of my excessive interest payments, and sprinting in the right direction. Right?

Wellll, right. Unless I get lazy and lose focus for a few weeks. In which case I’m on cruise control at 20 miles per hour.

Here’s what I mean:

A few weeks back I told you I had two Rainy Day categories I’d had to (almost) double-fund because they’re paid annually and I only had seven months to get ready for them (started saving in March for September payments).

I’d been putting $275 per month in my Life Insurance category in preparation for an $1,850 payment  ($275 x 7 = $1,925. Math may not be my forte after all.) I’d also been funding my Residential Lot payment at $320 per month in preparation for a ~$2,000+ payment.

Having made both those payments in early September, I can now drop the budgeted amounts to $140 and $165, freeing up $290 per month.

Dropping Sprint and moving to Ting is saving me another $110 per month.

Which means I should be able to open YNAB right now and see my Debt Snowball category with a $400 balance, ready to attack the nasty residential lot loan with the 10% interest rate.

So, let’s see…open up YNAB…go to the budget screen, scan down to the Debt Snowball category…and…huh?

0?

I must be some sort of magician, because I just made $400 in monthly gains disappear into thin air.

Yes, I could dig into my spending report and pinpoint the leakage. Off the top of my head I can think of a couple medical things and my daugther’s preschool that chewed up most of the extra money.

But that doesn’t mean I can throw my hands up in the air and decide that $400 isn’t available after all. I have to secure my gains. I specifically went after expenses like the cell phone bill to free up money for debt elimination, so that’s where freed up money has to go.

Solution?

Bill pay. I created a $400 automatic payment to go out on the same day as my mortgage payment each month. I never miss a mortgage payment; there’s no reason to miss a snowball payment.

Yes, the new snowball payment may require some scrambling. I may have to watch the account balances closely in the last couple of weeks of the month to ensure the new $400 payment doesn’t wreck the rest of the budget. I’ll have to increase my focus on collecting enough freelance hours to protect the snowball. The penalty for debt is discomfort.

By the way, I think this principle applies whether you’re talking about $400 or $40. When you make gains in your budget, secure them by automatically allocating freed-up money to your most important goal.

Could you cut up your credit cards?

Green VisaYesterday Chance (YNAB COO) and I were sitting in the office discussing the gravity of yesterday’s post, and addiction in general. It got us on the subject of my old post on debt addiction, and how I manifest something like 11 of the 15 signs of being addicted to borrowing.

The topic of credit cards came up, and Chance mentioned that he and his wife don’t use them at all, which I found interesting. Ironically, Chance and his wife are the type of people (as many of you are) who could use credit cards as nothing but a tool of convenience and security, without substantial risk of getting into debt.

I, on the other hand, have a history of running expensive credit card balances. Yes, it’s been a couple of years since I’ve had any personal balances on credit cards. But history proves my habit and my risk of future indebtedness.

The question, then, is why do I keep them? Yes, credit cards have benefits like convenience, more secure online purchasing, miles/points/cash back. But, for someone like me, do those benefits outweigh the risk?

*To be clear, I’m not anti-credit card. They’re just financial tools that can be used to a person’s benefit or detriment. 

I can’t answer that today, but here’s what I find really interesting: when I think about cutting up and closing the cards I have a strong emotional/physical reaction. It freaks me out to think about being without credit cards. I shudder at the idea of having balances again, but I also hate the idea of not having access to them. And I just think that’s interesting.

Am I the only one who gets a pit in my stomach when I think about life without access to credit cards? What does it say about me?

How to Pay off $26,000 of Debt in 18 Months on a $35,000 per Year Income

magnifying glassYesterday I featured Jenny and Aaron’s, well, debt. Today I’m covering their budget and showing them how they can be debt free in 18 months thanks to a debt snowball, work bonuses, and tax refunds.

This budget is based on two $1,350 paychecks per month. Health insurance and retirement contributions are withheld from paychecks, so don’t appear in the budget. 401k loan payments are also withheld from paychecks.

You’ll notice a lot of $0 categories. That’s a reflection of the change in lifestyle Jenny and Aaron will experience by committing to getting out of debt. Paying off the balances will allow them to start funding those categories again.

Category Budgeted Notes
Charity
Tithing $270
Other Charitable $30
Charity Total $300
Monthly Bills
Mortgage $877.59
Water/Garbage $50
Electric $70
Natural Gas $60
Cell Phones $50
Car Insurance $42.46
Netflix $7.99
Hulu $7.99
Home Security $0
Pest Control $0
HOA $10
Monthly Bills Total $1,176.03
Everyday Expenses
Groceries $270
Fuel $135
Household Goods $50
His spending money $30
Her spending money $20
Restaurants $25
Other Medical $10
Misc $0
Cash $0
Everyday Expenses Total $540
Rainy Day Funds
Savings/Buffer $0
Emergency Fund $0
Car Maintenance $20
Home Maintenance $25
Preparedness/Storage $0
Birthdays $0
Parties $0
Anniversary $0
Christmas $0
Other Holidays $0
Halloween Costumes $0
Date Night $0
Landscaping $0
Furniture $0
Clothing $20
Haircuts $10
Movies $0
Electronics $0
Swimming $0
Baby Stuff $0
Wedding/Baby/Grad Gifts $0
Church Stuff $0
Preschool $0
Rainy Day Funds Total $75
Savings Goals
Vacation $0
Flight Lessons/Plane $0
Weekend Fun $10
Anniversary Trip $0
House/Moving $0
Car Replacement $0
Back to School $0
Change $0
Savings Goals Total $10
Debt Payments
Car Loan $235.17
Credit Card A $140
Credit Card B $100
Credit Card C $100
Debt Payments Total $575.17
Budget Total $2,676.18

Jenny tells me Aaron’s annual work bonuses are very consistent (he works for a very large, growing company whose commercials you see every day). Although they’re expecting a raise before year-end, it won’t be huge and their tax refunds should be close to what they’ve been in the past.

It’s also worth noting that this snowball doesn’t include the two “extra” paychecks per year Aaron gets (because he’s paid bi-weekly), and it also leaves out the raise I just mentioned (which has already been approved).

In other words, as long as Jenny and Aaron live within their means, they can be debt free in a very reasonable amount of time. The snowball kicks off using $5,000 from the savings they’ve set aside for their two kids’ future. Although it’s emotional, they agree that they need to solidify their own finances before they can hope to help their kids.

Here’s the plan:

1. Use savings to pay off Credit Cards 1 and 2 completely. ($500 + $3,050 = $3,550)

2. Take another $1,450 from savings and, combined with payments from Credit Cards 1, 2, and 3, pay down as much of Credit Card 3 as possible. ($1,450 + $140 + $100 + $100 = $1,790)

3. This leaves Credit Card 3 with a balance of around $2,650. Make payments of $340 per month (combined payments from Credit Cards 1, 2, 3) from October to January (4 payments). Allowing for some interest, this drops the balance on CC 3 to ~$1,500.

4. In February, use first portion of annual work bonus to pay off Credit Card 3. ($1,500)

5. Combine remaining portion of work bonus with snowball payment ($340) and normal car payment ($235), and throw it all at the car loan. ($1,500 + $340 + $235 = $2,075). Because you’ll have made four more car payments between now and then, the car loan balance should be around $8,500, and the $2,075 payment will drop it to around $6,400.

6. Put your entire tax refund toward the car loan. If you get your taxes done quickly and get the refund in February, that drops your car loan balance to $1,400. ($6,400 – $5,000 = $1,400).

7. Using your new $575 snowball payment ($340 from paying off credit cards + $235 from car payment), your car loan will be paid off in three months. Which means credit cards and car will be paid off in May of 2014.

8. Apply the whole snowball to 401k Loan 1. You’ll pay it off in around four months. ($575 x 4 = $2,300). The loan will be gone around September of 2014.

9. Combine the monthly payment from 401k Loans 1 and 2 with your snowball payment and apply the entire amount to 401k Loan 2 for the four months between October 2014 and January 2015. ($6,500 loan – 4 x $650 = $3,900 remaining on 401k Loan 2)

10. Use $3,000 from 2015 work bonus and first $900 of 2015 tax refund to pay off remainder of 401k Loan 2. Game over. You win.

Jenny and Aaron – it’s going to be tight, but you can do it. Getting out of debt involves one big decision (“We’re through borrowing and we’ll do everything in our power to get out of debt.”) followed by small, daily decisions (“We’ll buy that DVD when we’re out of debt.”).

Work together and fight for your goals. When the snowball is done rolling, you’ll have freed up $600 per month – over 20% of your current take-home income, not to mention your annual bonus and any tax refunds. Life will be brilliant with no debt. Make it happen!

Living Within Your Means: The key that unlocks the door to debt freedom, peace of mind, and buying any Halloween costume you want.

Earlier this year, Jenny and Aaron were feeling like their income was at risk. Aaron’s position at work didn’t feel stable, and they both started feeling like a transfer within the company would solidify things. Without getting into detail, I can say their feelings seem valid, and I’d probably have made the same move given the same circumstances.

They applied for a transfer across the country that would keep Aaron in the same position, but working in a more stable office with realistic opportunities for advancement he had earned through his great performance.

The challenge would be the cost of the move, which the company would not cover.

With that backstory in place, let me give you Jenny and Aaron’s debt balances at the time they were making the decision to sell their house and move:

Loan Balance Interest Rate
Credit Card 1 $1,484.02 16.24%
Credit Card 2 $3,600.00 17.99%
Credit Card 3 $4,625.00 12.99%
Car $10,441.24 4.5%
Total $20,150.26

We’re looking at a little over $20,000 in debt. I’ve left the payments out of the table for now, because what I want to tackle with today’s post is the debt balances, and the decision-making process that protected these balances when they could have been eliminated.

See, those balances are as of February 28, 2013. It happens that January and February gave Jenny and Aaron a big cash infusion:

  • January was a three-paycheck month for Aaron, who’s paid bi-weekly (giving them an extra $1,400 and change above their typical monthly income).
  • They received $6,179 in tax refunds.
  • Aaron received a $3,000 bonus at work.

Jenny and Aaron are tithe-payers, so 10% of that cash went to their church.

Alright, so what’s the approximate “score” at that point in time?

  • $9,709 in credit card balances.
  • $9,521 in cash surplus (net of tithing).

Now, keep in mind, Aaron’s normal bi-weekly paychecks are coming in, so none of this bonus cash should be necessary for day-to-day living.

Jenny, I have to talk directly to you right now, because in our conversations you felt pretty strongly that the circumstances surrounding the move to the midwest were absolutely the reason your total debt has increased this year.

I’m sorry to be so blunt, but the math is right in front of you: the tax refunds and the work bonus could have effectively zeroed the credit cards. But they didn’t, and it really didn’t have much to do with the move. In February, when the tax refund money hit the checking account, here are some of the ways you budgeted it:

Birthdays: $300
Kids’ Parties: $65
Anniversary: $180
Christmas: $310
Other Holidays: $50
Halloween Costumes: $20
Date Night: $380
Couch/Furniture: $150
Movies: $48
Wedding/Baby/Grad Gifts: $20
Aaron’s Money: $553
Restaurants: $259
Miscellaneous: $707
Vacation: $1,768
Flight Lessons: $200
Weekend Fun: $67

I point out those categories and amounts because a) none of them have anything to do with moving and b) the amounts were much higher than what you budget to those categories in any other month. In other words, you took most of the tax refund money ($5,077 out of $6,179) and put it into your normal day to day living, rather than using it to pay down debt.

In your defense, it’s not like you spent all that money in the next month. Most of those categories still have positive balances. I’m pointing out the thought process that’s keeping you in debt. Rather than attacking the debt with the extra cash, you made sure your day-to-day living was intact.

THAT is how a person stays in debt.

You’ll say you funded those categories because you wanted to avoid surprise expenses that would force you to use the credit cards again. Better to get ahead of the expenses so you can comfortably work on the debt going forward, right?

No. In order to avoid future debt, you didn’t have to front-load a bunch of your categories. You simply needed to build a budget that fit inside your income, then fight to make it work.