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Tying the Knot… with Debt

Monday, April 13th, 2009

With the financial pressure on marriages increasing, divorce is a frequent outcome. Many of the problems that strain a marriage can be sourced to a difference in financial philosophy amongst a couple, and specifically to the variance in spending behavior and attitude towards debt. Jeff Opdyke explores this issue at The Wall Street Journal, writing, “The goal is to determine how you employ debt in your life together, the rules by which you each use debt separately, and your plan to pay it off so that it never has the chance to corrode your relationship.”

This advice makes sense. More communication about finances and specifically about the role that debt should play in their lives, including how it fits into the household’s priorities, is key. But equally important is coming up with the plan to pay it off – and executing and tracking it to measure success. In the past we’ve argued for individuals to come up with debt management and elimination plans. But couples with combined finances should seriously consider forming a debt plan together, and here’s how to do it.

Step One: Set up some of the basics.

Commit together to stop spending on credit cards completely. As a team, check each other’s progress and make sure that no plastic is being swiped moving forward. Review each other’s credit card statements to not only stay on the same page, but to get as accurate a total view of one’s household finances as possible. Brainstorm on all of the different debt accounts outstanding between the two individuals, bring together all of the debt paperwork for each person, including cash account information, and start to organize it – first into rough piles, then make those piles more specific – by type of debt, interest rate, etc. Most importantly, avoid judging each other in the process. Wait and do a systematized evaluation of the debt once all of the information is clearly out on the table.

Step Two: Figure out a monthly payment commitment.

Identify the monthly minimum that must be paid as a couple. Then add on top of it, since paying only the minimum makes the debt even more expensive moving forward.

Step Three: Select a debt strategy.

Debt stacking, snowball, and constant payments are the basic approaches. Choose one of them, bearing in mind that although the constant payments strategy is the simplest to plan, it optimizes debt reduction the least.

Step Four: Set up a system for debt reduction.

Use a monthly tracking spreadsheet, and execute your payments before deadlines to prevent punitive fees. Review your debt reduction progress each month.

Bonus Step: Once you’ve got a handle on the four core steps, try to reduce the debt burden by calling your lenders and negotiating for lower interest rates, identifying and applying one-time sources of cash towards debt elimination payments, and setting up a separate checking account to use to pay down debts. Even better, take a stab at increasing your monthly debt reduction commitment payment.

Raj Patel writes for DebtGoal.com, a do-it-yourself system for getting out of debt and lowering your interest costs.  DebtGoal.com incorporates all of the techniques discussed in this post and can help users understand and get visibility to and manage their debt finances.

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Pay Off Debt More Quickly with Debt Stacking

Monday, March 2nd, 2009

If you have a debt problem, you may have considered other options such as bankruptcy, debt settlement, or credit counseling.  However, if you are current with your payments and can make minimum payments, your best alternative is to pay off debt on your own, as the alternatives are expensive and can damage your credit for up to 10 years.  In this article we will explain the different payment strategies for getting out of debt on your own and the pros and cons of the different techniques.

If you’ve decided to pay off debt on your own but are confused about the various strategies to best make payments, you’re not alone–there are many competing strategies claiming to be the best.  To keep this simple, we will review three popular strategies for making your monthly payments.  All three hold the total monthly payment amount constant but allocate this payment differently between the accounts.  We will compare these to making minimum payments which isn’t a very good strategy, but we will include it as a point of comparison.

  1. Constant Payments on each account: with this technique, the borrower pays the a constant amount on each account each month until the debt is paid off.  This is the simplest mechanism to execute, but doesn’t allocate debt to the highest interest debts.
  2. “Snowball”:  with this technique, the user holds the Monthly Commitment constant, makes minimum payments on all accounts but the lowest-balance account and allocates as much as possible to this lowest-balance account until it is paid off.  After that account is paid off, the borrower shifts focus to the next lowest-balance account and continues to apply as much as possible to this account.
  3. “Debt stacking”:  this is the most efficient technique and is the one advocated by DebtGoal.com, as it can result in savings on interest costs of nearly 10% relative to the other techniques.  With this approach you hold your Monthly Commitment constant, but make minimum payments on all accounts but the highest-interest account (your Target account) which receives all excess payments to pay it off as quickly as possible.  After this Target account is paid off, you shift your focus to the next-highest interest account, making it your Target, and apply as much as possible to this account while paying only minimums on all others.

To make this simple, let’s assume that you only have two credit cards:  one with $4,500 at 15% with a current minimum payment of $180 and a second account with a balance of $6,700 at 18% with a current minimum payment of $268.  Let’s also make the big assumption that there are no new charges on the card.

Minimum Payments

As mentioned, this is not a good debt reduction strategy, but it’s a useful point of comparison.  With these two cards, you will start with a combined minimum payments of $448 in the first month.  However, since each payment reduces principal, your payment in the second month will be less than the first.  And since you will pay off some principal in the second month, your month 3 payment is still lower.  Although your payments start at $448 in the first month, in month 12 the total payment has decreased to $338.  resulting in $110 less being paid toward principal in this month than if payments were held constant.  You get the picture…your payments keep declining and although this may sound good, it will take you a long time to pay off your debt: about 11 years, during which you will pay $5,704 in interest.  Grade F.

Constant Payments

With constant payments, you simply hold the payment on each account constant over time, even though your minimum payments decrease.  This has the advantage of not reducing your payments over time and therefore paying an increasing amount of principal off each month, getting you out of debt quickly.  It’s also easy to execute, since you just hold your payment constant on each account.  But you could do better by taking the difference between the constant payment and your new, lower minimum payment on your lower-interest card and applying it to your highest-interest card.  If you hold your payments constant at the amount of the initial minimum payment, this approach will pay off your debt in 32 months, during which you will pay $2,900 in interest.  This is a savings of $2,840 compared to paying only minimum payments, but not top of the class.  Grade B+.

Snowball

Thanks to Dave Ramsey, the Snowball approach may be the best known of the three approaches.  Under this scenario, total payment amount is held constant over time (here at the sum of the initial minimum payments) but reallocate the amounts freed up by the declining minimum payments to the lowest-balance debt.  This can be seen in the payment graph where payments toward the lowest-balance account increase over time.  This has the advantage of being the quickest mechanism to paying off an account and giving you a motivational boost, but does not guarantee that this money is being applied to debt efficiently.  In this case, it allocates more to the lower-interest debt.  Holding your total payment constant at the combined initial minimum payment of $448 pays off debt in 32 months with $2,943 in interest.  This option may make you feel good for paying off your first account and you’ll save $2,800 compared to only making minimum payments.  Grade:  B.

Debt Stacking

This is the most efficient approach of the three.  Like the others, we hold the monthly amount constant at $448, but allocate the money freed up by lower payments on the 15% card to the higher-interest card, which we call your Target account.  Because it is the most efficient payment strategy it pays off debt earlier, in 31 months with only $2,660 in interest–a savings of 11% compared to the snowball technique.  This option is the most efficient and saves nearly $3,100 relative to making minimum payments.   Grade: A.

Summary

All of the payment techniques that hold your monthly payment amount constant are dramatically better than just making minimum payments.  The most important conclusion is that just by holding your payments constant at the current level of minimum payments you can pay off your credit card debt in just under 3 years without expensive Debt Management or Debt Settlement services that will negatively impact your credit score long after your debt is gone.  In short, just by making constant payments you can get out of debt on your own very quickly.

The only disadvantage to any of these techniques is that you will have to maintain a monthly payment schedule.  For many people, this can be a daunting task.  It is for these people that we have developed DebtGoal.com, an online application to help users create and track against a Debt Stacking plan.

The Impact of Constant Payments with More Accounts

We walked through this example with a fairly simple scenario.  With more accounts and different types of debt, the power (and savings) of technique grows.  If we add a $320K mortgage at 6.5% to the mix and again hold the payment constant at the minimum amounts over time, the savings become truly impressive.  Debt Stacking will save you $119K in interest and get you out of debt nearly 8 years earlier.  All without spending more on your debt than you do today.

Additional Resources:

The power of compounding interest
The cost of making minimum credit card payments
Debt settlement
Create Your Debt Paydown Plan
DebtGoal debt reduction plan worksheet

Scott Crawford is CEO of DebtGoal.com, a do-it-yourself system for getting out of debt and lowering your interest costs. DebtGoal.com incorporates all of the techniques discussed in this post and can help users understand and get visibility to and manage their debt finances.

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Pros and Cons of Debt Settlement

Sunday, March 1st, 2009

You see ads frequently on late-night on TV promising to lower your debt to just a fraction of the current amount.  These ads are for a type of service known as Debt Settlement and while the service can offer legitimate help to overwhelmed borrowers, it’s not a solution for everyone nor is it a decision you should take lightly.

What is It?

So what exactly is Debt Settlement?  Debt settlement is a negotiated settlement between you and your lenders for less than the face value of your debt.  Although the experience can vary by provider, it generally resembles the following:

  • The debt settlement firm will qualify you to make sure you have a significant amount of unsecured credit card debt.  Generally speaking, you need to have at least $10-15K in credit card debt to qualify.
  • You will sign a contract with the settlement company under the terms of agreement.  This will lay out the amount you will pay for service, generally 30% of the amount that the firm estimates will be forgiven under a settlement program.  Most estimate that they can settle for approximately 50% of original loan balance.
  • You will then quit paying your unsecured lenders until you have paid the entire amount due to the settlement company.  During this time, you will accrue finance charges and late fees that will increase the balances of the debts significantly beyond the original amounts.  Your accounts will go to internal collections and then may be sold to aggressive external bill collectors who may call you frequently.
  • After you have paid the debt settlement company and have built up an additional balance, your settlement firm will go to your creditors and offer to settle with them for amounts less than the original balances.
  • This process will continue until the settlement company has contacted all creditors.

Pros and Cons

It should be clear from the above description that there are some fairly significant impacts.

  1. The service isn’t cheap–you’ll pay about 10-15% of your total balances to the settlement firm.
  2. You will be contacted frequently by collections companies and this can be stressful.
  3. Your balances will grow quickly with finance charges and penalties.  If you drop out of the debt settlement program or if your lender declines to negotiate with you, you may leave the program owing more than you did when you started.
  4. Success depends on the willingness of lenders to accept a settlement.  Some lenders will and others won’t.
  5. Your credit report will be very damaged for a period of 7 years.  If you’re desperate enough to sign up for a settlement program, your credit may already be so far gone that this may not be a major consideration.
  6. The forgiven debt is taxable in the year in which it occurs, so you will need to come up with additional cash to pay the taxes.
  7. Debt settlement only impacts unsecured debt.  I won’t help you with auto, student, or mortgage debt.

Is Debt Settlement for You?

So is Debt Settlement right for you?  Maybe, but it’s a more limited solution than the ads would have you believe.  In general, it’s better than bankruptcy but worse than credit counseling or getting out on your own.  In fact, many state statutes lay out guidelines for Debt Settlement that specifically describe when it is appropriate.  If your problems are confined to credit card debt and you are currently significantly late on your payments and will not be able to make minimum payments going forward, this may be a better solution for you than bankruptcy.  Like Ch. 13 bankruptcy, it can reduce your debt burden and allow to make progress against your debt.  But like bankruptcy, it comes at a high cost to your current and future credit.

If you are current on your debt and can make minimum payments, we encourage you to make every effort to pay off your debt on your own.  By creating and following your own debt reduction plan, you can save thousands of dollars in interest and pay off your credit card debt in just under 3 years.  DebtGoal.com can help you create and track to a personal debt reduction plan.

Additional Resources:

The power of compounding interest
The cost of making minimum credit card payments
Debt settlement
Create Your Debt Paydown Plan
DebtGoal debt reduction plan worksheet

Scott Crawford is CEO of DebtGoal.com, a do-it-yourself system for getting out of debt and lowering your interest costs. DebtGoal.com incorporates all of the techniques discussed in this post and can help users understand and get visibility to and manage their debt finances.

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Create Your Own Debt Paydown Plan

Sunday, March 1st, 2009

Over 65% of people who set a goal to get out of debt never create a plan. They never set an amount that they will pay each month, set up a mechanism to track their success, or put a target date to be out of debt. It’s no surprise that the success rate for these people is low–without a detailed action plan, there’s simply nothing there.

In this article, we outline the process for managing a debt payment plan on your own.  If you decide that you’d like an online solution to walk you through this process and to help you stay on track, consider using DebtGoal.com.

Step1:  Set up the basics

  1. Quit spending on credit cards.  It’s clear that you can’t pay down your debt while continuing to spend on credit, so stop.  Shred or otherwise destroy your cards.  Share your techniques to quit spending and see how others fight the urge at the DebtGoal Quit Credit Card Spending Forum.
  2. Organize your finances for success.  Having the right structure can make progress much easier.

Step 2: Define your Monthly Commitment

Making only minimum payments on your debt is expensive as these minimums will decline over time, dramatically lengthening the time it takes to pay off your debt.  For this reason, the most effective debt payment plans start with a constant total monthly amount.

To determine how much you can pay each month, start with the sum of your minimum payments–this is the minimum of what you’ll have to pay and it will get you out of debt quicker than you think.  From there, look at your past 60 days worth of spending to determine if you can increase this amount.  Find an amount equal to or greater than the sum of your combined monthly payments that you can commit to paying each month.  I always feel that it’s best to start with a conservative amount and the increase it a few months later if you determine that you can.  This amount your Monthly Commitment.

Step 3:  Choose a debt payment technique

Once you have chosen a Monthly Commitment, chose one of 3 strategies for allocating this total amount to each of the debt accounts:

  1. Constant payments on each account: with this technique, the borrower pays a constant amount to each account each month until the debt is paid off.  This is the simplest mechanism to execute, but doesn’t optimize repayment by putting as much as possible to your highest-interest debt.
  2. “Snowball”:  with this technique, the user holds the Monthly Commitment constant, makes minimum payments on all accounts but the lowest-balance account and allocates as much as possible to this lowest-balance account until it is paid off.  After that account is paid off, the borrower shifts focus to the next lowest-balance account and continues to apply as much as possible to this account.
  3. “Debt stacking”:  this is the most efficient technique and is the one advocated by DebtGoal.com, as it can result in savings on interest costs of nearly 10% relative to the other techniques.  With this approach you hold your Monthly Commitment constant, but make minimum payments on all accounts but the highest-interest account (your Target account) which receives all excess payments to pay it off as quickly as possible.  After this Target account is paid off, shift your focus to the next-highest interest account, make it your Target, and apply as much as possible to this account while paying only minimums on all others.  Continue until all debt is paid off.

Step 4:  Create a system for executing your plan

This is where it all comes together and it can be difficult unless you have a good framework to keep you on track.

  1. Create a monthly spreadsheet to track your repayment.  We have included a DebtGoal worksheet to help you execute a Debt Stacking approach.
  2. Make your payments each month, making minimum payments on your minimum-payment accounts and applying any excess to your highest-interest Target account.
  3. Adjust your Monthly Commitment for credit card spending in prior months.  This is one of the keys to successful debt repayment: if you make payments but continue to charge, you will need a method to adjust for this or you progress will be slowed.  To adjust, take any credit card spending from previous months and add this amount to your Target account payment.

Step 5:  Advanced techniques

These techniques are not necessary for success, but can speed up your debt repayment.

  1. Lower interest costs by renegotiating credit card rates or refinancing your mortgage.  Studies show that over 50% of people who ask their card issuers for lower rates get their rates lowered by about one-third.  If you can lower your rates, be sure to keep your monthly commitment constant–your lower rates will allow even more of your Monthly Commitment to go toward your debt.
  2. Increase your Monthly Commitment:  evaluate and cut your expenses to increase the amount of your Monthly Commitment going forward
  3. Find one-time sources of cash:  consider applying savings to debt or raising money to apply to debt by selling little-used possessions.
  4. Create a separate checking account to pay your debts  Set up direct deposit from paychecks to put the right amount in each month and use this account to “pre-fund” your debt payments.  With this technique you won’t have to worry that you won’t have the money to make your debt payments.

This article covers the basics to creating a plan to pay off debt.  As with most things, there are several acceptable techniques and it’s important to find one that works for you.  Ultimately, the ideal technique for you is the one that makes sense and that you can follow. Above all, commit to a monthly payment that you can dedicate to debt payments each month and track your payments and your progress. Half the battle is just tracking your results-your behavior often follows.  As you start on this process, you’ll notice that it’s hard at first but that it grows easier over time.

If you find that tracking and executing your plan manually sounds difficult, try DebtGoal.com, an automated tool to help you create and execute a plan for getting out of debt.

Scott Crawford is CEO of DebtGoal.com, a do-it-yourself system for getting out of debt and lowering your interest costs.  DebtGoal.com incorporates all of the techniques discussed in this post and can help users understand and get visibility to and manage their debt finances.

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Late Credit Card Payments? Skipped Due Dates? What are your options?

Saturday, February 28th, 2009

The stress caused by late credit card payments can be unrelenting. But there are options to get back on track.

1. Take a deep breath.

Before you can start work on even getting organized to address the debt, take a moment to gather yourself and breathe, take quick power nap, meditate, or do anything else that clears your head for a moment of the problems of payments on a credit card. Getting back on track is possible with a straightforward game plan and an honest look at your financial picture.

2. Know your current status.

Facing your late credit card payments, or even skipped payments starts with understanding your debt status. Spend some initial time just pulling together all of your paperwork and details on each debt account that you have. Sounds confusing? It does not need to be, especially since the cost of inaction is steep. Grab a sheet of paper or open a spreadsheet, and start listing each account. Write down each of the following: the company that manages the account, their contact phone number, the total amount owed on the account, and its interest rate. Call the company if you don’t have any of that information on hand.

3. Set up a basic system.

Can you set up a basic system to pay off the debt? Dealing with skipped or even late credit card payments can be clear. If the total debt amount is small over multiple accounts, use the snowball method or debt stacking and monitor your progress each month until it is eliminated. From where are you going to get the money to make the debt elimination payments each month? Set up a quick, rough budget and cut out the discretionary expenses until the debt is eliminated. If this still seems difficult to do, start researching how to lower your interest rates on the debt.

4. Identify Zero Percent Balance Transfer Options

Yet another strategy for dealing with late credit card payments exists. Research options online with which you can have your current credit card balances transferred at zero percent interest. Choose balance transfer options in which the time period during which the zero percent is active is long, ideally one year or more. Keep in mind that this can only be a temporary solution: an opportunity for you to aggressively pay down debt before the zero percent period expires. Be careful since these balance transfer options can include high interest rates after the zero percent period ends, can have initial fees associated with them. In the meantime, to avoid creating any future problems with payments on a credit card, stop using the plastic and better yet, cut up any zero percent balance transfer card you receive.
  

Raj Patel writes for DebtGoal.com, a do-it-yourself system for getting out of debt and lowering your interest costs.  DebtGoal.com incorporates all of the techniques discussed in this post and can help users understand and get visibility to and manage their debt finances.

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