Monday, February 16, 2015

If you find yourself in debt, then what?

Think of the first time you went into debt. Did you fully understand the terms of the loan? Did you pay off the loan as fast as you originally thought? Did you pay it off sooner or later than you originally thought? Did you know or realize how much interest you would be paying? For many Americans, they get their first credit card in college, with some student loans to go along with it. Little to no thought is put into how this debt might be paid off, only the hope that a college education will allow for a higher income that will be able to pay things off some day.

I recently received an e-mail from a friend who wants to get out of debt but didn't really have a plan on how to do so. He is in his late 20s, earns about $40,000 per year, and has about $10,000 in debt from three student loans. He has been paying a little extra on the loans but didn't really know how much he should be paying, or whether it really made a difference to do so or not. My advice to him was this.

  1. Reduce 401k contributions to not be contributing anything that isn't matched (his employer matches up to 7% but he was putting in over 10%). Stop contributing to any other retirement accounts (He has been adding about $200 a month towards a Roth IRA).

  2. Focus on the smallest debt of about $2,000 first. Not only will it be paid off first, but it also has the highest interest rate. Until the first debt is paid off, don't pay more than the minimum on the two larger debts of $4,000 each.

  3. Don't keep more than $1,000 in checking and savings combined while paying off debt. This will allow you to pay off debt quicker and will help act as a small buffer in the event of an emergency.

  4. Put as much as you possibly can towards your debt payments each paycheck. As you pay off one, you'll be able to start paying down the next one with even larger payments since you no longer have any minimum payments towards the first.

  5. Track expenses and set up a budget to be able to better control where your money goes. After doing this for just a short while, you'll be able to get a better feel for how much you can put towards your debt. You may also discover that you are spending more or less on some things than you were aware of. You can then make an informed decision as to whether or not you'd like to keep spending at those level.

If you're familiar with Dave Ramsey, a lot of this may sound familiar. He coined the phrase 'debt snowball' for this strategy. There are some differences between what I recommended and what he recommends, but the overall concept is the same.


With these initial changes in place, this is what the updated scenarios look like for him. These compare the amount of interest that will be paid and the date that he will be debt free based on whether he pays only the minimum monthly payments, a little extra like he has been doing, or if he implements the plan I put together for him.

He was paying a little extra and was on track to pay his loans off a year ahead of schedule, but these changes enable him to pay his debts off an additional two years sooner. I am convinced that he will be able to pay things off even sooner than the updated scenario shown here, but this where he is starting. As he continues to track expenses and follow a budget, he will be able to identify additional areas where he can find some savings to help speed up the process.

Should any other readers want a customized and comprehensive debt pay-off plan, feel free to reach out ( and I can help you organize a debt payoff strategy. If you find yourself currently in debt and are looking to become wealthy, the first thing to do is to stop getting further into debt and begin paying off debt as quickly as possible.

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