Debt: How to get out (9 Steps) and STAY OUT!

Debt.

Is there a more foul four-letter-word for us in the middle class?

Soul-crushing, marriage-ruining, ulcer-inducing DEBT.

Debt is your enemy and your family’s enemy.

It is robbing you of your future earnings – and with it, your future happiness (see this article on divorcesource.com on US Divorce Rates and Statistics that states “Of all the common items on the agenda of domestic disputes … money disputes were the best harbinger of divorce” – yikes!  In the immortal words of Jimmy in Pulp Fiction: “I don’t wanna get f**kin’ divorced!”) .

My rule of thumb is that every dollar of new debt you take on today will cost you more than $2 tomorrow.  Stay with me here, here’s my way of thinking:

• $5000 credit card balance with a reasonable (for a credit card) 15% APR paid at $75 / month will cost you $5817.69 in total interest and take more than 12 years to pay off!  Each dollar cost you about $2.16.
• A $40,000 car loan at a (again, reasonable) rate of 4.25% over 5 years will cost you $4,470.93 in interest.  I know, you’re saying “Hey MCD, each dollar only cost me $1.11!  And I get to tell everyone I drive a luxary, foreign car!”  I say your wrong and here’s why:
  • Being middle class and getting briefly caught in the upper class vortex of “I deserve this,” signing on the dotted line (without parting ways with any actual, earned money) and getting to drive off in a fancy, $40,000 car is one thing.  You don’t have to start dealing with the realities of a $741.18 / month debt payment until next month.  But, if you had to scrimp and save and use real, accumulated, worked for dollars for that car – dollars that you traded time with your family for – upper class vortex or no, you’re spending $20,000 or less on that next car.  If you’ll spend $40K cash on a car, hand in your middle class card.  By my MCD logic, the credit monster ate $24,470.93 of your money when you financed a $40,000 car – a cost of $2.22 tomorrow for each of today’s dollars.
• A $300K, 30-year mortgage at a fixed, 4.5% interest will cost you $247,220.13 in interest: $1.82 for every dollar (I said it was a rule of thumb, not perfect).  You could have bought a second house for that $247K!
• Add these up – you buy a $40K car (when you would have bought a $20K car if you had to pay cash), you get a 30-year $300K mortgage and buy $5K worth of furniture for the new house on a credit card, all at the same time.  Fast forward 12 years, here’s your state of affairs:
  • Between interest payments and the $20K you overpaid on that shiny car, you’ve paid $173,929.09 ($143,640.47 mortgage interest, $5817.69 credit card interest, $4,470.93 car loan interest, $20K car overpayment) in money you cound have kept.
  • You have a 12-year-old car that hasn’t been fancy for eight years.
  • You still owe $224,752.42 on your house.

Have I sufficiently driven home the point here?  Debt is your enemy!  Avoid new debt with every fiber of your being!

Okay MCD, I get it!  No more new debt.  What about the debt I already have?  What’s the magic in getting rid of that?

The short answer is… there is no magic.

If you’ve drown yourself in so much debt that your credit score is now negative and you are parking your car at a neighbors so the repo man doesn’t take it away, you might be able to talk your creditors into reducing the amount you owe in exchange for a payoff or starting a regular payment again.  This is only because they figure if they don’t agree you’ll declare bankruptcy on them.  Which, honestly, if you are this bad off might be the next “magic” payoff idea for you.

The comments above aside, again: There is no magic.

Paying off debt is not magic, it’s brute force:

1. Get rid of the “I deserve this attitude.”  You and your family deserve a future free of debt.
2. If your married, talk openly with your spouse about debt, get on the same page about paying it off and get excited.  If you’re not married, confide in a close friend (since most of us are embarrassed by our debt, who knows?  Your friend might be in worse shape than you!) and share your milestones with that friend as you pay off debt.
3. Put together a budget, if you haven’t already, and commit to sticking to it.
   

   Go old-school with your budgeting!

4. Eliminate as much of your discretionary spending as possible.
   • Cancel cable TV (~$75/month).
   • Cancel your home internet (if your job doesn’t depend on it) (~$75/month).
   • Reduce your cell phone bill (suggestion: switch to Google Project Fi) (~$75/month from two phone lines).
   • Cancel Netflix, Hulu, etc. (especially if you were able to eliminate your home internet!) (~$10/month).
   • Set your thermostat lower in the winter (say 62F) and put on a sweater.  Buy a fan and skip the AC in the summer (we are in Georgia – yes, this is possible, even with young kids – people survived thousands of years without AC!) (~$40 – 200/month).
   • Save the eating out for special occasions (and not more than once every three months even then).  Pack your lunch for work / kids school.  Once a week, feed the kids leftovers and have the adults skip dinner (quite literally, tightening the belt).  Assuming you ate out just once per week at a modest cost of $75 each time, we’ll call this $300/month.
   • Combined savings somewhere in the $575 – $775 / month range.  Even if you aren’t able to do all of the above, you can probably find minimum savings of $300/month using these ideas.
5. Boost your income if you can, even if it is only occasionally.
   • Get a better paying job.
   • Work overtime if available.
   • Rent a room in your house.
   • Take on an additional part-time job (perhaps drive for Uber or Lyft, babysit via Care.com, grab some work on elance if you can code, create digital art or have accounting skills to offer).

• Conventional wisdom is to build an “Emergency Fund” of 3 to 6 months of spending before you start paying off debt.  Screw that.  The point of an Emergency Fund is to keep you from having to take on debt when something bad happens.  You’re already swimming in debt, attack it head on – no use spending the next year getting killed by interest rates while you try to build up a 3 month reserve!

6. If you’ve got a fancy, expensive car with a ridiculous monthly payment – sell it.  You might actually have to save up money to be able to sell it.  If you owe $36K on your car and it is worth $32K, you’ll need to come up with the $4K difference for the privilege of being without a car.  If public transit isn’t an option for you, save up $6500, buy a car for $2500 and sell your car.  Trust me, the almost $750/month you’re saving is worth it.
7. Now you know from your budget and your adjustments in incoming and outgoing money what your surplus per month is, as well as how much total debt you have.  Do the math, figure out your out-0f-debt date.  Put it up on your bedroom door, in your car and at your desk.  Live that date and try to beat it!
8. Now it’s time to pay off your remaining debt utilizing the extra money your saving.  Your debts may include:
   • Credit card debt.  This is likely the highest interest rate debt you have.  List all your credit card debts smallest to largest.  Apply every extra dollar you have every month to paying off the smallest of these debts and work your way up.  As you pay off cards, you’ll build more and more “extra” money each month to put toward the next (this “debt snowball” method was popularized by debt elimination advocate Dave Ramsey).
     

     Tackle credit card debt first.

     • Bonus technique: If your credit standing allows, see if you can take out a new 12-month 0% interest credit card and roll your highest APR debt(s) to this, then pay off as above.  Even if all you have left is 0% APR cards, stick with ridding yourself of this credit card debt first.  You don’t want to be stuck playing the balance transfer game forever.
   • Installment debt.  This might be furniture or… whatever else they still do installment loans for these days.
   • Student loan debt.  I hope to God you are seeing real, monetary value in your job from this debt (otherwise… what was the point?).  Depending on how much student loans you have (we know folks with less than $10K and others with a nice, house-sized student loan debt ($200K+)) – you may want to explore other options for addressing your student loan debt.  More on this in a future post.
     

     Student loan debt. =(

   • Auto loans.  If you didn’t sell your car and pay cash for a beater, you probably still have a car loan out there.
   • Mortgage payment.  If you’ve got a lot of other debt, you’ll want to leave your mortgage alone and just keep paying minimums until everything else is paid.  Once you’re down to just your mortgage you’ll want to run the numbers and see if it makes sense to refinance or not.  More discussion on mortgage payoff will come in future posts.
9. When credit cards have been paid, put your mortgage debt aside, list all your other debt smallest to largest and pay them off in that order.  “But MCD, why not largest interest rate first?”  You’re at war with your debt.  You need to start winning some battles and eliminating the smaller, weaker enemies so they aren’t there to distract you when you take on the bigger, stronger adversaries (meaning, psychologically, you’re more likely to see the task through to the end (eliminate all debt) if you meet milestones along the way)!

Follow the above advice and you’ll get clear of all your debt, except for your mortgage (which I’ll make the subject of a future post) and you’ll never take on new debt again.  This will not be easy.  It will not be quick (it took us about 2.5 years after we got super-serious).  It will not be fun.  Honestly, it will suck.  But it will be worth it (…it might just save your marriage).

What do you do with all this extra money every month that used to go toward servicing your debt?

1. Decide the areas of your “belt tightening” that were most painful for your family and loosen up (maybe add back internet and Netflix).  Don’t get carried away with this – you’ve gone this long without eating out four times a week!
2. Decide how much money to save towards your next car.  That beater you bought is going to die sometime.  $300/month gets you $14,400 cash in four years.  You can find some really nice options of 3-year old used cars for that much money.  $167/month buys you a “new” $2000 car ever year (and you’ll keep saving on car insurance)!  Figure out what fits your middle class mindset best and save appropriately.
3. Divert the rest to saving / investing / paying off the mortgage (details in a future post).  Diverting these funds should happen without giving you an opportunity to spend them first (meaning if your choose to pay down your mortgage an extra $500 a month, setup your direct deposit to send these funds to your mortgage checking account and setup your additional automated principal payment accordingly) – if you never see the money you can’t spend it!

What are your debt payoff strategies?  How do you feel about aggressively paying down debt without first building an emergency fund?  Do you have any debt payoff war stories?  Comment below!