We’re calling this 2A because everyone doesn’t need this lesson. This is specifically for people who have too much debt that you’d like to pay down. Having debt is not inherently bad; having a high percentage of debt can be. It affects your credit scores; it affects your ability to obtain good debt, it can affect your health. So let’s talk about getting rid of it in a timely fashion.
**Please note, these are not methods I’ve invented, but I know they work**
The Envelope System
- The Envelope System – if having enough money to pay your bills is a problem for you, it’s time to remove all other spending. That’s right, no entertainment, no dinners out, no extras, until you know what is happening with your money. Not paying bills timely has bigger ramifications than not buying coffee this week.
- The basics.
- Take your paycheck in cash. If you have direct deposit, go withdraw your entire paycheck in cash. I know, this sounds counterintuitive, but stick with me and see where this goes.
- At home, prepare envelopes for EVERY one of your bills: the mortgage, the phone bill, the power bill. Whatever you pay monthly, give it an envelope. Use the worksheet HERE to help you remember what those are.
- On the front of the envelope, write the date due and the amount. e 25th $200
- Now, put the cash in each envelope. Start with your most important bills first. You know, keeping a roof over your head and the lights on. Netflix is not in this group.
- When you’re done, what’s left – more envelopes or more cash?
- If you have more envelopes, do you have another paycheck this month? Will you be able to fill the envelopes from that? If not, it’s time to re-think your employment or your spending.
- If you have more cash than envelopes, congratulations, but you’re not done yet.
- Think about food/snacks/meals until you get your next paycheck. How much will you need for that – create an envelope for it.
- Still have cash left over? Take 10% and put it in a savings envelope. Take the other 90% and put it towards a past due bill if you have one, or to a credit card bill. You’ll see which one to pick in the next section.
- Keep using the envelope system until you have all your bills current and a handle on your money. If that’s three months, great. If that takes a year, just imagine how much better off you’re going to be.
- How do you actually pay those bills? Go back to the bank and deposit the money only when you are ready to write the check. It may seem like more work, but the more often you are touching your money, the more mindful you will be.
- If you have an entertainment/food envelope – when it’s empty, you’re done. No going out with friends, you’ve spent your wad until the next time you get paid. Self-sabotage is super easy with restrictive things – do yourself a favor and stick to the plan.
The Snowball Method
- Great for use if you have lots of debt to different people/companies. This is the Dave Ramsay method.
- The basics.
- List all your debt on a spreadsheet. Include total amount owed and minimum payment. Re-sort so the smallest debt is shown first.
- Make minimum payments on all debts. If you have extra cash, apply it to the smallest debt balance first. The goal is to pay-off the smallest one.
- When the smallest debt has been paid off, take the amount you were paying on that one and apply it with the amount you have been paying to the next smallest debt.
- When that debt is paid off, take the whole amount you were paying on the smallest and next smallest debt, together with the minimum payment you were paying on #3, and apply it to that debt.
- You are snowballing the effect of your payments by continually increasing the amount paid to a specific debt.
- Eventually, all debt is paid, and the amount previously paid to debt is available for savings/investments.
- Good for you if you want to see progress quickly.
The Interest Rate Target System
- Great for use if you have lots of debt to different people/companies.
- The basics:
- List all your debt on a spreadsheet. Include total amount owed, minimum payment, and interest rate charged. Re-sort so the highest interest rate is shown first. This is your target.
- Make minimum payments on all debts except for the one with the highest interest rate. Extra cash is applied here first. The goal is to pay-off this one first.
- When the highest target debt has been paid off, take the amount you were paying on that one and apply it to the next highest interest rate target.
- When that debt is paid off, take the whole amount you were paying on the prior two targets and add it to your minimum payment for the next target.
- You are saving money by reducing the total amount owed. If you don’t need to see progress fast but are committed to spending the least amount of money. This one is for you.
- Eventually, all debt is paid, and the amount previously paid to debt is available for savings/investments.
In our examples, the debt is paid off at approximately the same time (remember we didn’t calculate interest) but the total amount paid will be less in the Interest Rate Target than in the Snowball System.
