Because its the new year and I briefly mentioned our plight to pay off debt in a random post at the end of 2012, I thought I'd sit down and write about what finally worked for us and our financial goals.
If you know us in real life, then you know that the hubs and I are not great with managing money, historically speaking. By not great, I mean that money basically burns a red-hot hole in our pockets the moment we get it. Okay, we're horrible with money. At least according to my mom.
That isn't to say that we're struggling to pay bills and stuff, because we're really not. We did at first, when we first got married and started living on our own, but that was mainly a lack of attention to what bills were due and when. A few times at the beginning of our marriage we found ourselves staring at a due date that fell the day or two before payday with $1.47 to our names. That is not a good feeling, folks.
Anyway, at the start of 2012, we were one measly year into a 30 year mortgage and suddenly became motivated to get rid of the rest of our debt that had slowly crept up to a slightly uncomfortable level. I won't lie and say that it didn't have something to do with the fact that we thought we were moving and didn't have any real way to pay our mortgage and rent should our house not sell, or renters skip out on us. It had a lot to do with that. Basically it scared us shitless. I also knew that on hubby's income there was no reason we shouldn't be able to pull the purse strings a little tighter and be float two house payments for a few months if needed.
There was no way we could do that with the debts we owed at the time. I had heard about Dave Ramsey and his idea seemed to make sense. So we (I) made a budget. A real one. Down to the penny every month. It is tedious. Tracking every cent we spend is definitely not fun, per se, but it has become somewhat of an addiction.
Here's how it works.
You start with a zero based budget. That means that you take your income, let's say its $3000 a month, and you tell it where to go. Basically this means that you assign every expense a category and a dollar amount. For example, your rent (or mortgage) might be $700 a month. Your electric bill usually runs you between $75 and $125 a month, depending on the weather. You spend $400 a month on groceries and $250 on gas. You get the picture. Next you compile all those categories into a budget in which you go line by line and assign dollar amounts until you run out of money.
It kind of sounds scary to say "run out of money", but the idea is that you have sinking funds and other categories in your budget that don't get completely used up each month. So even though you have $125 left over at the end of the month, you know that $25 of that is earmarked for new clothing and $100 is set aside for future car repairs.
Let me explain sinking funds a bit. A sinking fund is when you set aside money for something you know you will have to pay for later. For example, we have a yearly Homeowner's Association Bill that comes due at the end of the year. We knew about it all year, so instead of trying to scrape together the money this month when spending is already crazy, we saved it all throughout the year. So, if your bill is $1200 due in December, you save $100 a month every month and then the money is available when you need it.
The same idea goes for home and car repairs (and other bigger ticket things you can't exactly anticipate, like losing weight and needing new clothes). If you are just starting out with a budget a safe amount to budget for car repairs is about $75 a month per car, depending on your car. Now, if you know you need $1200 of new tires on your car and your hubby's car is a beater, then you probably need to set aside more than that. Use common sense. For home maintenance and repairs, the guideline is about 1-3% of your home's value. If you have a new or newer home, you might be able to get away with less for a bit, and vice versa.
Anyways after you have budgeted everything you hopefully have a little bit of money leftover. This is the money that will go toward paying off your debts. Let's say you have $200 left after all bills and sinking funds are paid every month.
The first step is to commit to no longer using credit. That means no credit cards, no financing, no payment plans, nothing. Next you set up a small emergency fund that will tide you over in case something happens and you need to make an $800 repair on your car or something. The suggestion is that this emergency fund be $1000, which is enough to give you a bit of security, but not enough to make you feel comfortable. You want to have a motivation to get out of debt. If you already have more than $1000 in a savings account, Dave Ramsey actually suggests keeping the $1000 and using the rest to make a lump payment on something.
After you use the $200 excess each month to fund your $1000 emergency fund* the next step is the snowball method. Basically you tally up all your debts and then list the minimum payments for each. These should already be a part of your budget, because presumably you're paying them each month. Here's an example:
CC1: Min payment $25, balance $500, interest rate 10%
CC2: Min payment $25, balance $5000, interest rate 10%
Car: Min payment $200, balance $10,000, interest rate 5%
SL: Min payment $500, balance $20,000, interest rate 2%
Obviously these are made up numbers, but you get the picture. Since you're already paying the minimums on all these debts every month, you'll continue to do that. With the $200 that you have left from your budget, you'll start to pay down the lowest balance. So instead of paying $25 to CC1 every month, you'll pay $225. In 2.5 months, once you have this card paid off, you'll take the $225 that you were paying there and apply it to CC2, making the new monthly payment to CC2 $250, because you include the minimum payment.
After CC2 is paid off, you "snowball" the $250 to the car payment, making it $450 a month that goes toward the car. As you can see, this picks up speed pretty quickly, allowing you to see progress and really feel like you have accomplished something! I should also add that DR says that any extra income (from gift money, side jobs, yard sales, etc.) should go directly into your snowball each month.
We started this plan in January 2012 with more debt than I realized once we tallied it up. As of January 2013, we have approximately 2 months left before our credit cards are paid off and our car loan will be paid off by the end of the year.
We have decided that instead of continuing the snowball after paying off the credit cards, we're going to take a break until hubby leaves and then I'll snowball the heck out of the car and get it done while he's gone. We both decided that since we'll be able to pay the car off by the end of the year this way that we want to have the extra money (and freedom) to have fun as a family before he leaves. We also have to travel to two out-of-town weddings this summer that we are funding.
But that is the plan in a long-winded nutshell. Its really rather simple, but I may have made it seem more difficult than it actually is. If you have any questions about the plan in general or our journey specifically, please don't hesitate to ask. I may reserve the right to not answer personal questions, but I'm more than willing to help if you're interested in getting started on the road to being debt free!
*Dave Ramsey actually suggests that it take you no more than a month or two to come up with the $1000 for your emergency fund. He recommends selling things you no longer use in a yard sale or babysitting to make some extra money. Basically you want to get this $1000 in place as quickly as possible so you can move on to the "fun" stuff, paying off debt!
