Monday, July 21, 2008

Attacking debt

Dave really pushes 'finding every penny you can' to throw at paying down your debt. One of the things that he says that is different than many other financial advisers is what order you should pay your debt. A lot of people want you to look at your interest rates and payments. Dave's plan is simple. You list your debts from smallest to largest. From there you do what is called a 'Debt Snowball'. You pay the minimum payments on all your debts (provided you're current on every thing), then you take every extra dollar you can find or earn and pay it on your smallest debt until it's paid off. Once that is paid off, you take the amount you were paying on that debt and add it to the next smallest. When that's paid off, you continue to compound the payments and keep attacking the debts one at a time. Basically the amount you pay toward debt each month never really goes down as you pay off your debt, you just add it to the next in a snowball fashion. He more or less considers people 'debt free' when all you have left is your house, but he still encourages you to pay that off too.

Some people would question why you should pay so aggressively on debts with 0% interest or low rates. I know I did. That was until we had some unexpected expenses come up. Suddenly I realized how much more flexible you can be when you don't HAVE to make a credit card payment. When we started eliminating debts, it freed up a significant portion of our budget each month.

That's where we stray from Dave's plan. Tim gets quarterly bonuses and my income is very inconsistent, so we've had to alter things a little. We started with the smallest debt and went down the list, but we're not always able to compound the totals after they are paid off for a snowball. On our off months, we don't always have the ability to pay the full snowball amount, i.e. we can't always afford to pay $500-$1000 month on debts, so we just pay what we can. Then we commit to large payments from our extra income (bonuses, my income, sale of goods, etc). The way we do it so that we don't feel "deprived" is we put 75% of all our extra income toward debt and the other 25% either gets added to the budget for line items or our 'blow fund'. Some months this means a larger grocery bill so we can stock up on occasional items. Other times it gives us a chance to splurge on things like decorating Troy's big boy room.

This has been extremely successful for us. We've paid off Tim's credit card, our car (we're lucky his company pays for his car), my credit card, my attorneys, and put a significant dent in our second mortgage. My credit card will take quite some time, so we've already decided that we're going to start the 401(k) back up after the second mortgage is paid off - yes, he says to suspend your 401(k) while paying off debt. Radical, I know, but it works.

So, there you have it. This weekend's garage sale will be no different. 75% of what we earn will go to debt. The other 25% will either go to the 'new window' fund or be used to buy new clothes to replace the ones the kids of outgrown. We haven't decided yet. Hopefully we'll make enough to do both.

Debt Goal: Have the 2nd mortgage paid off in less than 1 year from now.

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