Where I am now – Part 1

My post is a little long so I decided to break it into two parts so I don’t bore you to death.  This is Part 1.

If you haven’t, please read my story so you can see where I was financially only a year ago.

Things have changed a lot since then.  Ever since I started a budget and kept track of my spending I have been able to save way more money than I thought possible.  I paid off my car and all my credit card debts.  I only have my student loans left but I have paid half of what I owed and have under $10,000 left to pay.  I no longer live with my mother.  My girlfriend and I moved into an apartment together.  I have a three-month emergency fund, which I will continue to grow, I increased my 401(k) to get the full match from my employer, I started contributing to a Roth-IRA, which I maxed out for 2013, and I was able to save extra money to buy my girlfriend an engagement ring, I now get to call her fancy girl – I mean, Fiancée.  Did you know that a Fiancé is a male that is engaged to be married and a Fiancée is a female that is engaged to be married?  Well, I didn’t.  And if you didn’t either then you just learned something today…you’re welcome.

I still have a lot of work to do and a lot more to learn but I would like to take this time to give you a brief summary of the steps I took to get to this point.  I mostly followed the steps described in Dave Ramsey’s “The Total Money Makeover.”  I will have a review on the book and write about each step in detail in later posts but let me start by saying that even though I don’t agree with some of the things he says, I highly recommend his book if you are struggling with debt.

Steps I took

1. Created a written budget
2. Saved at least $1,000 emergency fund.
3. Paid off debt.
4. Built emergency fund of 3-months expenses.
5. Changed contributions to get full match on my 401(k).
6. Started Roth-IRA

There are more steps to follow but I am not there yet.  For example, pay off your mortgage, get the right insurance, save for college, etc.  I don’t have a house or kids yet and I have life insurance through work so I will worry about those when the time comes.  Actually, I might do something about the right insurance this year.

Create a written budget

This is by far the first and most important step that I took and that you should take.  A budget should be priority numero uno.  A budget helps us keep track of our expenses; if we don’t keep track of our expenses then it will difficult to know how to allocate our money.  After I started a budget, I found that I had about $700 a month that I could use to tackle my debt and after a few months I found that I was saving even more than that.

Things we need for a budget are a piece of paper, a pen or pencil, our monthly income and our monthly expenses.  Write down your monthly income and make a list of all the expenses for that month.  Subtract expenses from income and if you have more income than expenses then you are in good shape.

Example Monthly Budget

Monthly Income	$3,000
Rent	$1,500
Car Payment	$300
Utilities	$500
Food	$300
Entertainment	$100
Savings	$200
Total Expenses	$2,900
Money Leftover	$200

Subdivide categories accordingly (i.e. "Utilities" should be subdivided into gas, electricity, water, etc.)

 

If you like to keep track of your budget on the computer I suggest you do an online search for “free budget spreadsheet” and you will find plenty of spreadsheets to work with.  Choose whichever works best for your situation.  The free versions are very simple to use but you do get what you pay for, so if you want something more sophisticated then maybe do some research on paid budget tools.  I use two free spreadsheets, which I will show you in my “All about budgeting” post.  Once you have a realistic budget, you will see that either you DO have enough money to save or you will need to make some sacrifices.  I found out that I had more than enough money for expenses and for savings so I was lucky I didn’t have to make too many sacrifices.  Everybody’s situation is different but you will not know until you have a budget.

Creating a budget was simple but it took some time to get it right.  I found myself moving money around every month because I misjudged how much I spend on groceries and how much I spent going out.  So don’t get discouraged if this happens to you, just make the adjustments and keep tracking your expenses.

After I had an idea of how much money I could save, I just made the minimum payments on credit cards, car, and student loans and saved up a mini emergency fund as fast as I could.

$1,000 mini emergency fund

I save up $1,000 real fast.  I made minimum payments on all my accounts and saved $700 the first month, then $300 the second month and used the rest to start paying off my debt.  The reason why I needed at least $1,000 is because I didn’t want to use my credit cards for emergencies anymore. You can save more or less, depending on your situation but you need some cushion just in case something happens and trust me, emergencies do happen.  Your car could break down any minute and it’s good to know that you have money to repair it without going into any more debt.  Do this as fast as you can.  If you have to make some sacrifices the first few months, do it and save at least $1,000.

Now that I had some cushion for emergencies, I didn’t worry about saving any more.  I just took any extra money that I had and paid off my debt.

Pay off debt

There are two proven methods to pay off debt:  The Avalanche Method and the Snowball Method.  They are different ways to approach your debt and each has its advantages.

The Avalanche Method is where you make a list of all your payments and arrange them from highest interest rate to lowest interest rate.  You then make minimum payments on all your balances and try to pay off the account with the highest interest rate first.  The advantage of this method is that you end up paying less in interest in the long run; the disadvantage is that the account with the highest interest rate might be the one with the biggest balance and it might take you longer to pay it off and there’s a chance you might get discouraged by thinking you will never be able to pay it off.  It happened to me many times and that is why I  recommend the Snowball Method.

The Snowball Method is simple.  You make a list of all your payments but you arrange them from the smallest balance to the biggest balance.  You make minimum payments on all of your balances except the lowest balance.  Once you pay off the smallest balance you take whatever amount you were using to pay off that balance and you add it to the second lowest and so on.  You are creating a snowball effect.

For example, let’s say you have credit cards A, B and C.  Credit card A has a balance or $900, card B has a balance or $3,000, and card C has a balance of $11,000 and to keep it simple let’s say they all have a minimum payment of $25.  Now let’s also pretend that the interest rates for the cards are 16%, 13% and 9% respectively.   If you decide you have $200 to pay your debt then you pay $150 to card A, $25 to card B and $25 to card C.  Once you pay off card A then you will take the $150 you were using to pay card A and apply it to card B.  Now your payments will be $175 to card B and $25 to card C and so on.

The advantages of this method is that it gives you a moral boost after you pay off the first balance and it encourages you to keep going.  The disadvantage is that you might have to pay more in interest overall.  Why would I want to pay more?  You don’t but the moral boost you get when you clear that first hurdle is priceless.  This approach works best to tackle your debt according to a study done by researchers at the Kellogg School of Management.  This is the one and only time where paying more interest might be beneficial…maybe.

Choose the method that you feel is right for you, but make sure you tackle one balance at a time and pay the minimum on the rest.

These first steps are the most crucial to get out of debt fast.  The other steps are to build a decent nest egg and live a more comfortable life.  I will write about them in Part 2.

How do you keep your budget?  Which debt paying method works for you?