No Debt Plan

No Debt Plan is a blog about living a debt-free life. If you're new here, you may want to subscribe to my RSS feed (e-mail subscription also available). Learn more about me, or some of my most popular posts. Thanks for visiting!

This has been a long time coming. I’ve been meaning to write this for weeks. You can read more about The No Debt Plan, or get caught up on the first few individual steps.

If you’ve been following the steps of the plan, this is where you should stand:

• You should have a budget, and know where every dime has gone in the past few months. Your budget should tell you where each dime is going to go this month as well.
• You’ve done whatever it takes — cutting of expenses or increasing your income — to achieve free cash flow.
• You have some sort of emergency fund. It could be $1,000 as recommended by Dave Ramsey, or 3-6 months of expenses. Each situation will be different. Do what seems prudent for your family situation. If you have debt, I wouldn’t put more than 6 months away as that may take you a long time.

If you haven’t yet achieved those things you can go back to the steps linked above to catch up. Now, Step Four…

Pay Off All Consumer Debt

Consumer debt is the bane of my existence. Not for me, but for you, my readers. Consumer debt is defined by InvestorWords.com as:

“Debt that has been incurred primarily for the purchase of consumer goods …”

So anything that isn’t your house counts as a consumer good. Some might even consider a house as a consumer good depending on why you bought it.

If you purchased something because you couldn’t wait to save up for it, and you paid interest for it (or still are!) that’s consumer debt.

Some quick examples:

• That 46″ LCD High definition TV that you bought on your Best Buy credit card. Interest rate of 19.99%.
• The new BMW sitting in your driveway, payments of only $499 per month.
• A new iPhone that you put on your credit card for two months with interest at 14.99%.

All of the above are poor financial choices. You’re paying interest on goods that over time will be worth less than they are today.

How to Tackle and Pay Off Your Debt

There are several popular methods to pay off your debt. Dave Ramsey says to go after the smallest amount first regardless of interest rate. Suze Orzman does the opposite. She wants you to pay the minimum payment plus $10 to every debt, then any remaining to the debt with the highest interest rate. You can see a great comparison of the two methods at The Simple Dollar.

So what should you do? What do I recommend?

Do something. Either of the above are fine. I’d rather you start paying extra on your debt whichever way possible. However, tweaking Suze’s method is by far the best mathematically.

3 Steps to Pay Off Debt:

1. Rank your debts in order from highest interest rate to lowest interest rate.
2. Pay the minimums on all debt.
3. Any additional money goes towards the debt with the highest interest rate.

Mathematically, this is the least expensive option because you are actively paying down the debt that is costing you the most every month. It is also the fastest method bearscause you acrue the smallest amount of interest versus the other methods.

Psychologically, it may feel better to pay off several small debts very quickly. I’m not here to make you feel good. I’m here to get you out of debt. I’m not sure why Orzman wants you to pay an extra $10 toward every debt. That’s not going to make a huge difference in interest saved.

Pay off the highest interest rate debt first, and move your way down. And good luck. This step may take some of you years to run through. That’s the consequence of past actions. But stick to it… the grass really is greener on the other side.

This is the fifth post in a series: The No Debt Plan.

You just set up your budget. Let’s take a look at it. Where do you currently stand? Do you have money left at the end of the month, or are you going deeper in debt?

This concept is called free cash flow. If your cash flow at the end of the month is negative, you are just digging a deeper debt hole. If your cash flow is positive at the end of the month, then you are accumulating savings or cash. I found two business related visuals that go with this, but I don’t have the rights to them. Instead, here are links to business examples of positive cash flow and negative cash flow. And yes, you might consider running your life like a business. The concepts work exactly the same in this case.

We call it free cash flow because cash ‘flows’ from the top (income) down through expenses and hopefully into your pocket. Even $1 of positive free cash flow is something to be celebrated.

If You Have Positive Cash Flow…

Even if it only that measly little dollar, positive cash flow is where you want to be. If this is your current situation, congratulations. You are well on your way. Even if you are deep in debt, your positive cash flow can begin to chip away at the debt. For starters, you need to build up an emergency fund. We’ll talk about that next time.

Again, positive free cash flow means that you have cash left at the end of the month. You can put that cash to work in whatever way is necessary — savings, debt repayment, or investment. Strive to continue having this each month.

If You Have Negative Cash Flow…

Simply put this means you have no money left over at the end of the month, plus some additional debt. You have somehow found a way not to default on your debt, but you had to borrow more money to make it through the month.

I have some bad news for you. If you don’t do something to change the situation, you will eventually end up bankrupt. That is simply mathematical fact — after a certain period of time, you won’t be able to borrow your way out of debt. It will end somewhere.

You don’t want that. I don’t want that for you. So how do change your situation? I can’t do it for you, but here are suggestions:

• Cut everything you are spending money on out of your life. Of course you can’t cut literally everything, but this is what psychologists tell us the average human needs: shelter, food, water. That’s it. The basic necessities.
  • Shelter doesn’t mean…
    • A $500,000 house on a $50,000 income. Sell, and rent an apartment.
    • Keeping the thermostat at 77 degrees in the winter and 65 degrees in the summer. Lower the temperature in the winter, raise it in the summer.
    • A house, apartment, or condo full of nice things. Sell your HDTV, cancel your cable.
    • Cut everything that costs you a monthly fee unless it is absolutely necessary.
  • Food doesn’t mean…
    • Filet mignon at the fancy restaurants every weekend. It doesn’t mean elaborate meals at home every week. Cut your lifestyle, eat simple. Bread, peanut butter, jelly and some fruit should work just fine.
  • Water doesn’t mean…
    • Beer, soda, or even orange juice in the fridge. Water comes from the tap, you can filter it if you must. It is extremely cheap. Don’t buy expensive bottled water, either.
• Alternatively, you can earn more income.
  • Do anything you can to earn more money as long as it is legal. There are millions of ideas out there, so I won’t go into them here. Even if you had to bag groceries at a grocery store, or sweep floors at a factory, it is worth it. Remember, you have to get to positive free cash flow as soon as possible.

This may seem extreme, but I hope it opens your eyes. You cannot maintain negative cash flow indefinitely. It is only a matter of time before you can’t pay any of your bills. Make a change today. Get on the road to financial freedom. Cut some expenses. Get a part-time job. Get going!

This is the fourth post in a series: The No Debt Plan.

I have been afraid of writing this post for some time. Out of anything I will ever write on this blog, this is by far near the top of the list of the most important topics. To succeed in your financial life, to run your No Debt Plan, to really understand what is going on… you must be able to budget. There is no alternative. Call it a spending or savings plan if you like, when it comes down to it they are all the same — a budget.

Definition

From Webster’s Dictionary:

4 a: a statement of the financial position of an administration for a definite period of time based on estimates of expenditures during the period and proposals for financing them; b: a plan for the coordination of resources and expenditures; c: the amount of money that is available for, required for, or assigned to a particular purpose

Whew! Quite the mouthful.

I define slightly differently. A budget is a tool that

• lets you see where your money is coming from, and
• lets you tell it where to go

I think that last little bit is especially important. A budget doesn’t tell you where your money went. Your money shouldn’t be going anywhere without you knowing about it. It does show you were you told it to go.

The Pieces of a Budget

Your budget will have three main pieces - income, expenses, and free cash flow. Hopefully income is greater than expenses. This leads to free cash flow. I’ll talk more on understanding free cash flow in the future, but essentially it is what is left after expenses are deducted from income. If everything is going well, it is a positive number. If you are spending more than you are earning, it is a negative number.

Income is simply any money you bring in during the month. We typically only count income from jobs in this category. We use gifts, rebates, or money made selling personal possessions differently. Expenses are the things you spend your money on. Rent, utilities, food, gasoline, debt minimum payments, and car payments are all examples of an expense.

Where to Start

The budgeting process can be very eye opening. If you are sitting at your computer reading this and you have no idea where your money goes each month, a budget will solve that very quickly. Again, the goal is not where to see where your money is going, but for you to tell it where to go. But! If you don’t even know where it is going, a budget will do that too.

So, where do you start? Let’s just start at the top of the list above: income. Where is your money coming in from, when does it go in your account, and how much is it. For most people this should be pretty simple with just one job. Total the amount of money you expect to bring in every month, especially this month. Precise numbers are better than generalities, but anything will do at this point.

Next up are your expenses. This can be where the headache starts, so try not to get discouraged. A lot of data is involved because you aren’t normally spending all of your money in one location (unlike income, which is usually just one or two sources). To get this data, look at your bank accounts and credit card activity statements. This should cover most everything. The bank accounts will cover cash withdrawals as well as debit card use. Credit cards will show you each location you are spending money. Figure out what category each purchase is in. Sometimes you just have to pick one category if it is mixed.

Now compare the two categories. If your income is $3,000 after taxes, and your expenses are $3,400… you are in the hole. If expenses are $2,900 you have some breathing room. Either way, you now know where you stand. Now what?

Tell Your Money Where To Go

Line up all of your expenses and determine how much you should be spending on them. Make a list of expense categories. Put what you normally spend next to the category name. Now, determine where you can cut back. This is where you are telling your money where to go. Commit to spend only $300 on groceries this month and don’t allow yourself to eat out. Call your cable company to reduce your cable package. Cancel that gym membership.

Once you make your adjustments, look at the bottom line. How much extra money could you save if you implemented your changes? This is money that can be applied to debt (and later in the process, for savings). Remember, you don’t necessarily need to earn extra income if you can commit to just cutting back.

This is a huge step and it does require some work. You aren’t going to find yourself debt-free in the future without doing some work. Later on in the process I’ll share some tools you can use to help set up a budget.

This is the third post in a series: The No Debt Plan.

A key step to getting yourself out of debt is to see the light at the end of the tunnel. You need something to motivate you along the way. Something to track and chart. A little thing to remind you of why you are sacrificing and living the frugal lifestyle.

Of course, those little things are goals.

Goals help you see past the day to day issues you face on your path out of debt. For goals to be useful, there are some stipulations. Those stipulations are called S.M.A.R.T. goals.

S.M.A.R.T. stands for specific, measurable, attainable, realistic, and timely. These are all sort of interlinked together.

• Specific means the goal is not general. In terms of debt, a general goal would be “To become debt free” or “Pay off my credit cards”. A specific goal tells, as you would imagine, a lot of specifics. “To pay $25 extra principle on all three of my credit cards” is a specific goal.
• Measurable means the goal can be counted or progress can be tracked. “Save money” is not measurable. “Save $25″ is measurable; you can tell whether or not you saved $25.
• Attainable and Realistic means you can actually achieve the goal. It is realistic, although challenging. This is very important as you tackle debt. If I am $25,000 in debt, and my goal is to have $1,000,000 in my savings account one year from now… well, let’s just say that is a nice goal. It is not realistic.
• Timely means there a time factor associated with the goal. Again, a goal such as “get out of debt” or “save $1,000,000″ does not have a date associated with it. You are much less likely to achieve the goal if there isn’t a time associated with it. Placing a date at the of the goal, no matter how far away, means you will be more likely to hit it.

So what are some solid, SMART goals? (Note: these aren’t our actual goals.)

• To pay off the 16% interest credit card by August 1, 2008.
• To save $300 per month towards our emergency fund for the first six months of the year.
• To save $2,500,000 for retirement by age 58.
• To pay off our home mortgage by April 2015.

The list could go on forever. I encourage you to try using SMART goals in your life.

So you’ve decided you can have an Honest and Positive Attitude for your No Debt Plan? Time for Pre-Step #2 - a Long Term View.

True enough, getting into debt can seem relatively easy. It can be. Yet you probably didn’t get yourself into this situation yesterday.

Along the same lines, you most likely won’t be able to fix this overnight. If you just created this problem yesterday, you could make some drastic choices and get out of it tomorrow. For those of you that are seriously in debt, this is going to take a while.

Remember, we’re being honest and positive. This all sounds brutally honest, and it is. How can it be positive?

I think the positive part is that you are seeing the light at the end of the tunnel. It may be the size of a pinhole and be six years away, but it is there nonetheless. When you have debt piled up to your eyeballs, it may seem you will never get out. Being able to see the end of the tunnel no matter how far away is a serious change of view.

We’ll talk about this in the next section, but having goals will help you clarify how long this trip is going to take you. Once you know where you are going, you can get on your way. Six years may seem like a long time from now, but imagine the years after that without that debt cloud hanging above your head!

This post kicks off a series that will develop my plan for getting you out of debt. This may seem an odd topic for me to tackle; the only debt we hold are student loans that are in deferral. Yet I have read, seen, and heard the damage debt can do to individuals and couples. I hope you can take a small piece of everything I write with you on your way to the land of no debt.

Before we can talk about budgets, interest rates, credit cards, frugality, or retirement… we must discuss attitude.

A negative attitude will severely hinder your attempts to climb out of debt. Why? Getting out of debt isn’t a cakewalk! They are going to be hurdles and stumbles as you climb out. You can view each of those challenges in one of two ways: positively or negatively.

If you run into an obstacle, a negative attitude will just slow you down in overcoming it. It is a true momentum killer. You have to stay focused on the end goal: getting out of debt.

Second to a positive attitude is an honest attitude. You can’t play games with yourself. Take a good, hard, honest look at your situation. Face the music. Look at everything in your situation — not just some of the pieces. Do you have a negative cash flow at the end of every month? Do you know how much you spend each weekend going out to dinner and drinks with friends?

It isn’t hard to take an honest look at the data — credit card companies and banks send you statements. You should be able to decipher from these where your money goes each month. The data is there. The only thing stopping you is you.

So be positive, take your lumps when they come, and be honest with yourself. Do that, and you are well on your way to reaching any goal — especially getting out of debt.