Eliminate the Debt Factor

I will start with a basic situation first with this one to show how crippling debt can be.

Imagine a family with 5 credit cards, and 2 car loans. We'll say that each card has a $1000 balance and minimum payments of 2% or $20 to each card every month, so total payments of $100 a month for the credit cards. The cars both have monthly payments of $300, for a total of $600, and a grand total of $700 a month.

$700 a month in minimum payments, and this doesn't talk about a mortgage or student loans which many people will also have.

Now the average family in America makes $40000 a year, so this family with $700 in debt is spending about 21% of it's income on minimum payments. Everyone should ask the question, What could I do with that extra $700 a month?

How do I get rid of that debt? after all I'm paying the Minimum.

The key is to pay as much more than the minimum as you can comfortably afford, lets say an extra $200. Simultaneously you stop using credit cards. This prevents your debt from increasing. With that $220 ($200 + $20 minimum payment) a month you will have one card paid off in 5 months. Now you have a spare $220 to put towards the next card $240 will pay it off again in 5 months with some change left over. Your third card gets paid off in 4 months with change left over and so on.

Reward yourself after you pay off a major debt. Take the family out to eat or something, thank them for their efforts. It is important that they feel good about eliminating debt so they don't make the same mistakes you did.

Once you have all your debt paid off, you are in a great position to save, set up a CESA (Coverdell Educational Savings Account) for your kids, or set it aside in a money market for a downpayment on a new home, or make an Emergency Fund. The more money you can put towards the debt, the faster it will be gone, consider cutting back on shopping, eating out, cigarettes, and alcohol if you want to see the most dramatic results.

Crisis?

This post doesn't follow the series, but recent events have made me want to share it with you.

My wife had an asthma attack last night.

For a family budget, expenses associated with this would fall somewhere between recurring bills and emergency fund. Most people are good at the recurring bills, you pay the same (or similar) amount every month and forget about it.

The Emergency Fund is different.

First let's get a definition: The emergency fund is an area of liquid assets that is used only for unexpected expenses in regards to health, property damage, loss of income, or other similar emergencies.

The Emergency fund should be one of your first steps towards a sound financial picture for your family. Set aside quite a bit every month until you have roughly 3-6 months income put away. Then put that money to work in a money market account where the interest is higher than a savings, and where penalties for too many withdrawals will help you to think twice about accessing those funds.

The emergency fund is also helpful during times of family transition, for example: Say a new father wants to take some time off to spend with his wife and new baby, but his company only provides leave for women. The couple could access the emergency fund to provide that extra income for a few weeks and to help with the countless new expenses associated with baby. What if they didn't have an emergency fund? Those expenses tend to make it onto credit cards, which leads to more bills, and paying later for something you no longer have (ie. food).

As far as paying down debt, some people say to pay off the credit cards and unsecured loans first, others say build the fund first. It really doesn't matter, just make sure your plan will work for you. If you have a habit of paying only minimum balances, then you should pay the cards off first. If you always pay the full amount on your card and never even have to pay interest, you don't have to worry since you don't have that kind of debt. Consolidating that debt is another option which could bear fruit for you by letting you pay off the cards completely (hide or destroy the cards for a while after this or you'll run them up again). Then you are back in the easy recurring bills part where you pay the same amount every month.

So how do we cover an emergency like asthma? We use the emergency fund!