Archive for the ‘snowball’ Category

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Top Five Ways to Spend a Furlough

Friday, February 27th, 2009

As pressure on private and public organizations to trim costs mount, managers are looking into ways to reduce expenses while preserving staff. One of the increasingly popular strategies is placing employees on a furlough – a temporary leave of absence, often unpaid. USAToday is asking readers to email in the various ways in which they are spending their time off from work due to a furlough. Here’s a list of the top five ways someone in debt can make productive use of their furlough.

1. Get organized. One of the biggest obstacles from a behavioral standpoint to reducing debt is being caught in an unorganized environment, where one might not know where paperwork is located, while suffocating in a cluttered home and/or workspace. Overcome this by dedicating the first slot of time during your furlough towards getting organized. Achieve this through “baby steps” – organizing general piles, then more specific ones, etc. Get a stack of cheap file folders and start filing documents in different categories. 

2. Formulate a financial plan, and specifically a plan to reduce debt. In the process of organizing your “stuff” keep the financial and especially debt-related documents all in one handy place. Dedicate an hour or two to simply reviewing them to get a general understanding of your debt status, e.g. accounts, amounts, locations, and interest rates. Set some quick priorities. One of the best ways to priortize is paying off the debt amounts with the highest interest rates first. This approach can be combined with the snowball method.

3. Take the time to cut out unnecessary yet recurring monthly expenses. A major impediment to trimming your discretionary expenses in order to make room for debt reduction payments is simply the time and effort involved in contacting the subscription providers, gyms, and other service providers that charge you automatically on a recurring basis. Dedicate some time during your furlough to make these calls and cancel the services. Not only can those funds saved be put to more productive use, recurring automatic charges are one of biggest roadblocks to effectively reducing debt.

4. Spend time with family. Take the kids on a hike, play board games, and support them in their school activities. The essence is to spend time with family that does not cost funds out of your pocket (other than your time). In the current environment, spending time together as a family helps to reduce stress by getting everyone on the same page and reiterating support for one another.

5. Restrategize on your income and job. Take on contract work. Hunt online for temporary gigs that are flexible enough that you can finish work by the time your furlough ends. These projects will generate cash for you while you wait for the paychecks to start flowing again. Also, prepare yourself for job elimination. If you’re on a furlough, that may presage losing the position. Refresh and retool your resume, write sets of generic cover letters that can be quickly customized for different opportunities. Prepare a short job-hunting strategy, just in case. Work and debt are deeply interrelated since your ability to generate income impacts your debt reduction success and vice-versa.

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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Posted in Debt Management, Spending, snowball, stress | View Comments

The Cost of Having Too Many Debt Accounts

Tuesday, February 24th, 2009

In a previous article, we discussed the cost of minimum payments and how making minimum payments on credit cards greatly extends the time it takes to pay off debt and leads to more interest costs compared to a strategy of holding your payments constant.  But what should you do if you have more than one debt?  What’s your best strategy then?

Let’s take a look at an example.  Suppose you have 3 credit cards, all with $5000 balance and interest rates of 18%, 12%, and 9%.  Furthermore, let’s assume that minimum payments for each account are 4% of the balance so they each start at $200 per month.  With this example, there are 3 strategies:

  1. Pay minimums on each account until they are all paid off
  2. Pay $200 on each account until they are each paid off
  3. Pay $600 total, but allocate as much as possible to the highest-interest account until that account is paid off and then apply as much as possible to the next-highest account, etc.

So what does this look like?  When would you be out of debt and how much would you pay in interest?  Here’s a summary:

Strategy

Interest

Years to Debt Free
Minimums Only

$5,500

10.2
$200 per month to each account

$2,654

2.8
$600 each month with allocation to highest-interest account

$2,450

2.4

Clearly keeping your payments constant is still a good strategy, but you cut your interest costs by about 10% and get out of debt 5 months earlier by paying only the minimums on everything but your highest interest accounts and allocating the difference to the highest-interest account so you pay it off as quickly as possible.  This approach is often called “debt stacking”.

Debt stacking is the most efficient way to get out of debt and its power grows with more accounts at different rates.  If you were to add a $280K mortgage and a $15K auto loan to this scenario, how would that look?

Strategy

Interest

Years to Debt Free
Minimums Only

$365,877

29.9
Debt Stacking

$183,651

15.3

So with Debt Stacking, the borrower gets out of debt in half the time and cuts total interest costs by $180K.  Wow!  All that from just keeping payments constant over time at the initial minimum payment amounts.

So why doesn’t everyone do this?  Often it’s just too complicated for most people to manage on their own.  It requires creating a separate payment schedule each month to calculate the optimal payment on each account.  For most people, it’s just easier to pay the minimum payment on their statements and credit card companies use this to their advantage.  With this example, it’s relatively easy, but the average person in debt has 12 accounts and some have up to 30.  With this many accounts, the calculations required to follow the Debt Stacking strategy is too much.  So for many people, the cost of carrying many debt accounts is the paralyzing complexity that keeps them paying the amount on their statements instead of a more effective strategy.  In this case, that cost is pretty steep–$180K.

DebtGoal.com helps users get organized and create and track to a debt reduction plan.  Our application manages the complicated math required to create, follow, and track against an optimal debt payment strategy.

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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Posted in Debt Management, Debt Stacking, DebtGoal, Paying Down Debt, Saving, Spending, Uncategorized, snowball | View Comments

The Cost of Making Minimum Credit Card Payments

Tuesday, February 24th, 2009

In previous articles, we have explained how compound interest can work against you in paying down debt.  For each dollar of balance, you incur new interest charges that make paying off debt just that much harder.  To make the task of paying down debt worse, credit card companies suggest a “minimum payment” that will decline over time as your balance declines.  Although this sounds great, it actually works against you.  Read this article for a detailed explanation of why this “minimum payment” actually causes you to pay more in interest.

Let’s take a more detailed look at how credit card minimum payments work.  For this example, assume that you have a $10,000 balance on a credit card with 18% interest.  If you pay only the minimums, your balance will decline over time, but so will your payment and as a result the amount of principal that you pay off each month will decline as well.  Let’s compare this scenario to one in which you start at your current monthly minimum payment of $400 and hold it constant over time.  The following graph shows these payments over time:

Note a couple of things in this graph:  First, the minimum payments decline significantly over time while the constant payments stay constant at $400.  Second, the minimum payments are extended for 12.5 years while the constant payments end after 2.5 years.  This is when your debt would be paid off if you hold your payments constant-about 10 years earlier-all without paying any more than the starting minimum payment.

How does this impact how long it takes you to pay off your debt?  Because you pay more in each month under the constant payment scenario, this extra payment amount gets applied to your principal reducing it in the current month and resulting in lower interest payments in every subsequent month.  Because you’re future interest payments are lower, you apply more and more to principal in every following month.  Over time, this begins to rapidly reduce your balance…it’s compounding interest working in reverse.  Here’s what would happen to your balances in each of the scenarios:

So by holding your payment constant at the initial minimum payment amount instead of letting it decline over time, you can pay your debt off 10 years earlier.  During this time, you aren’t continuing to pay interest, so it stands to reason that you’ll save in interest.  How much?  Nearly $3,200!  All without paying any more against your account than your minimum payment when you started.  No wonder credit card companies encourage you to only make minimum payments-each month they lengthen the time it takes you to pay off debt puts more money in their corporate coffers.

So what’s the smart move?  Set a fixed amount that you can pay off each month against your debt even though your minimum payments decline.  This can become difficult if you have more than one account, especially if you try to optimize your payments by allocating as much as you can toward your highest-interest account.  This is where DebtGoal.com can help.  We help you set a constant monthly amount and stick to it over time.  As you pay down balances on lower-interest accounts, we calculate a payment schedule that automatically applies as much as possible to your highest-rate account, getting you out of debt as quickly as possible.  This technique can save an average family over $60,000 in interest over the lifetime of their 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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Posted in Debt Management, Debt Stacking, Paying Down Debt, snowball | View Comments

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