The Rungs
While you always do the budget and the envelope system, in order to get out of your financial hole, you will need to walk up your ladder rung by rung. Pick the rung you need to stand on right now and work that particular concept hard, until you are ready to move up to the next rung.
Resolve Immediate Financial Threats
Immediate financial threats are usually overdue bills, such as utility bills, car payments, doctor bills, the mortgage, and credit cards. We will cover two tools for you to use in this rung: your budget and excessive communication.
Take care in preparing your budget in a mature, responsible way. If you don't have enough money to make minimum payments on everything, wisely prioritize who should get cut short. Make sure you pay everyone something--no one likes being totally ignored, and--after all--you agreed to take their money or services and in return you agreed to pay them back. If you don't, you have lied to them.
But for those creditors you simply can't make a minimum payment to, send whatever amount you can pay them, plus a copy of your budget and a nicely written letter telling them that things are tough right now and you hope to be making minimum payments shortly. Make sure you send them some sort of partial payment each month.
And while you are on this rung, watch how you spend your money. I knew a lady who could not make all the minimum payments on her unsecured debts and she went out and replaced her perfectly good cell phone with an I-phone. What sort of message would this send to someone who had lent her money? Use the front page test--would you be embarrassed if your spending record for the past month showed up on the front page of your local newspaper?
Work this rung until you are making minimum payments on your debts.
Once you have taken care of the first rung and you are making minimum payments on all your debts, focus all of your financial energy on building a quick emergency fund. Without this fund, you will never get out of debt because when emergencies happen you will pay for them with credit. You need the emergency fund.
This fund will be used for--what else--emergencies. Emergencies are those things thak can bring a family to its knees. Emergenices fall into three categories:
- urgent home/apartment repairs
- urgent car repairs
- medical emergencies
Vacations, jewelry sales, and similar temptations are not emergencies. Neither are wallpaper and paint. Emergencies are when something you need unexpectedly breaks. Examples are the hot water heater, a starter for the car, and a replacement for the window little Johnny broke with his bat. A good quick emergency fund is $500 for every adult in your household, and $200 for every car in your household. So if your family has two adults and two cars, your desired quick emergency fund would be $1400 ($500 for each adult, and $200 for each car). Use this as a guide and decide what is enough for your family.
Don't feel bad when you have to draw money out of this fund. That's what it's for. Be grateful you didn't have to put the expense on a credit card. But when you do draw out money, build the fund back as quickly as you can.
I usually recommend keeping the fund some place you can get to quickly, but not conveniently. A money market account at a bank you don't use frequently, perhaps. If the money is too convenient, you will find yourself tempted to spend it on non-emergency items. Don't do that.
Prepare for Big, Short-Term Purchases
Great news: If you are on this rung, all your bills are current and you have $1200 or close to it in a quick emergency fund. Yeah!!!
Now you need to think about major purchases you want to make within the next year. A major purchase is anything over $500. They can include vacations, washers and driers, furniture, cars, etc.
When you're standing on this rung, you need to sit down with your spouse or significant other and create a list of these major purchases. Make the list together--you are a team, remember?
List the items on a piece of paper in priority order. Top priority first, lowest priority last. Next to the item name, list the cost of the item and where your savings for that item will be kept--in an envelope, in a bank account, etc. Then work the list from top to bottom, saving intensely for your highest priority item before saving anything toward the second item on your list. As you make deposits, note them on your sheet of paper--this shows yourself that you are making progress. You can keep the list on the refrigerator, just to remind yourself of what rung you're working on and to show yourself the progress you're making.
You may need to shuffle money around as priorities in your life change, but that okay. It's your money.
Most people want to start on this rung. Their debt load weighs on their mind so much they can't think about anything else other than making it go away. But you can't start on this rung. You aren't ready yet. You have to suit up in your armor before attempting to tame this dragon.
If you start working on your debt without a quick emergency fund, when an emergency comes up--and it will--you will have to get deeper in debt to pay for the emergency. You'll have to borrow the money from a friend or family member (not a good idea) or pay for the emergency with a credit card. And you can't borrow your way out of debt. So you have to have some savings before you work intensely on paying off debt.
If you have immediate financial threats, like overdue bills, your creditors will want you to jump in with both feet and pay off THEIR bill. But you have to look at the big picture and treat all your creditors with respect. You have to make choices that are in the best interest for you and your family, and you need some savings for emergencies upcoming and major purchases before you do that. You can't get out of debt without these things in place.
So when you are standing on this rung, you are making minimum payments on your loans and bills. You've got about $1200 tucked away for emergencies, and you've squirrel away some money for major purchases. Now it's time to use a weapon: the debt snowball. Here's how you get your debt snowball going:
Take out a piece of paper. Date it at the top. Title the paper "Debt Snowball." Make six columns on it. Title the first column "Debt," the second column "Minimum Payment," and the third column "Payoff." Then title the fourth column with a date four months from the date at the top of the paper. The fifth column is given a date eight months after the date at the top, and the sixth column is dated a year from the date at the top. It will look like this:
_____________________________________________________
today's date
DEBT SNOWBALL
debt |
min. payment |
payoff |
today's date plus 4 months |
today's date plus 8 months |
today's date plus 12 months |
|
_____________________________________________________
Using the form, complete the first three columns, listing your debts in ascending order with the smallest payoff or balance first. Do not be concerned with interest rates or loan terms unless two debts have similar payoffs, then list the higher interest rate debt first. Interest rates are usually a false target, so don't think about them that much. The interest rate is usually trivial compared to your big picture goal of paying off the total debt. Here's an example for someone in the future:
_____________________________________________________
3-9-2020
DEBT SNOWBALL
debt
|
min. payment
|
payoff
|
7-9-2020
|
11-9-2020
|
3-9-2021
|
Visa Discover Car Loan
|
$402 $392 $318
|
$16,408 $19,605 $21,412
|
Notice that we didn't put them in order by monthly payments, but rather by total payoff.
Once your first three columns are completed, each month, make minimum payments on all but the smallest debt. Pay as much as possible on the smallest debt. The amount you pay each month will probably change, since your budget for every month will allocate money a little differently. In four months, look up your total payoffs for each debt and complete the fourth column. Four months after that, complete the fifth column. In a year, complete the last column and make a new form.
When a debt is paid off, cross it off and treat yourself to something nice (debt free of course). Celebrate, because you are now one step closer to being totally debt free. This is a big deal. Treat it well, because when the only debt you have left is your mortgage, you have mastered this dragon and you can move up to the next rung.
On the second rung, you created a quick emergency fund of about $1200. This took you through most of your major emergencies, including unforeseen car and home repairs. But in reality, $1200 will not handle all emergencies. I remember when our hot water heater went out at our house, and I tried to fix it myself to save a few bucks. I'll save myself an embarrassing story, but suffice it to say it would have been cheaper if I would have just called the plumber in the first pace.
Some emergencies are expensive--like replacing a whole furnace or heat pump. Sometimes more than one emergency comes up at the same time. Sometimes the emergency relates to income, like when a layoff is announced by your employer.
To handle these really scary--and thankfully rare--expensive emergencies, the $1200 will not do. You need more. To cover these, you need a larger emergency fund. How much larger is tough to pin down. But usually it runs between $10,000 and 6 months of your NET pay.
How do you get this kind of money? I really don't need to tell you at this point, because you've walked up a lot of rungs on our ladder. At this point you know about the value of envelopes and budgeting. You know what financial discipline feels like. You know how humbling debt is and how freeing it is when it goes away. Continue these principles, and you'll get the full emergency fund quicker than you think.
What's next, you ask?
Well, let's look backwards for a moment. By this time you've gone to battle with some financial crises, and you won. You've had emergencies come up, but you were ready. You anticipated some future needs, and when they knocked on your door you took care of them and dismissed them. That's pretty nice.
At this point you sit better financially than about 95% of your neighbors. But you are not done. You've got kid's college to plan for; a retirement program to fund; and you can think about the legacy you want to leave behind in your family, your church, your community, and your world. You need to think about whether you are a keeper or a giver. You also need to be thinking about things like long-term care insurance, in case a dragon like Alzheimer's raises its ugly head in your life.
Yes, there are other rungs to climb ... other dragons to tame.
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