Today’s post is a guest post by David Brown,  a financial writer with Oak view law group

Have you been hit by the money bug? Are you suffocating under the burden of multiple debts? Well, debt consolidation can be one of your options. However, you need to know certain things before you decide to consolidate your debt. Read on to know more:

How can debt consolidation help me?

• If you have a poor monthly income right now then debt consolidation provides you the option of making lower installments over a longer period of time. It might certainly suit your current financial condition

• If you have several loans right now then you might be facing a tough time calculating interest rates. With debt consolidation you take a single loan to pay off all your debts. So you can manage your finances in a more organized manner.

• You need not handle calls from the collection agency. The debt consolidation company does that for you.

What are the shortcomings of debt consolidation?

• In most cases debt consolidation loans are secured loans. This means that you have to pledge some asset (your car or your home) as collateral for the loan. So you risk losing your assets in case you fail to pay back the loan. You should be confident about health, job and other unpredictable issues which can cause financial trouble. To be eligible for unsecured consolidation loans you must have a pretty good credit rating. Even if you manage to get a unsecured consolidation loan with a poor rating, it will probably not be big enough to pay all your debts.

• Many people wrongly assume that all consolidation loans have low interest rates. However it’s a different story altogether. In most cases the payment is lower because of the extended term and not the interest rate. Secured consolidation loans sometimes have a low interest. But it can still cost you if you are taking a long term loan, say for 30 years. In such cases you have to pay interest for a long period of time and over the years the interest might grow even bigger than the original debt amount. Depending on your present debt, the interest rates for these consolidation loans can be more than those on the pre-existing debt. That is what makes debt consolidation a profitable business for your lenders.

• Debt consolidation does not address the root cause of your debt-unwise money management. In most cases after someone consolidates his debt, it grows back. People have deceptive feeling that their debts have evaporated and they refuse to do away their poor financial habits. If you can’t spend less then there is no point in consolidating your debt.

• Sometimes it can take a long time to get a consolidation plan approved by your debtors. Your accounts can go unpaid for that time. They will show as delinquency on your credit report. Sometimes a consolidation company can negotiate debt with your creditors to reduce the amount you have to pay. This again will affect your credit report.

• Finally, if your financial condition is extremely critical then you might not be eligible for debt consolidation at all. With so much debt, you may be refused an additional loan.

Is debt consolidation an answer to your monetary problems? The answer to this question is different for everyone. Analyze your financial condition, consider the above things and then decide whether you really need to consolidate your debt or not.

Photo Credit: Photos8.com

Post from: Personal Finance And Investing

Is Debt consolidation the right solution for you?

This is a guest post from Fred from Credit Card Finder. Fred helps people to compare and choose the best credit card online.

If you’re in debt with credit cards, or personal loans and a mortgage you may be feeling a little nervous when you think about your lack of savings – but does it make sense to direct funds towards a savings account when the interest earned there will be overshadowed by the interest you are paying on your debt. There are ways to save when you are in debt, and there are financial products which can help specifically with this situation. So here are five years you can save, even if you have debt.

1 Consolidate credit cards to one balance transfer card

Try and avoid using equity or a line of credit on your home loan to pay off your credit card debt because you are in fact just stretching out your credit card debt for another 30 years, when you can target it now and get it out of the way for good. Instead, find a balance transfer card with a low interest rate which will allow you to transfer all of your credit cards to be charged one low rate. In this way you have your debt under control, you have a manageable monthly repayment and you have a payment plan which will help you get rid of your credit card debt.

2 In debt to 9%

Many financial planners and advisors will use the 9% rule – if you have debt which is charging you interest of more than 9%, you should direct as much of your income as you can towards paying down that debt. This means you should continue to pay your home loan as usual as it is unlikely to be charging you more than 9% interest in the current financial climate, and any personal loans you have are probably below 9% too. Instead you can focus your debt repayments on your credit cards as in the first point, after which time it makes sense to start looking at a savings plan.

3 High interest savings accounts

If you are going to save effectively while paying off your debt, you need to be getting the most out of the dollars you are directing towards a savings plan. Therefore, choose a high interest savings account which will give you the best return on the money you are able to put away. .

By depositing your regular savings to a high interest savings account, even if you have debt you are going to be able to earn a regular and attractive interest rate on your savings as the interest is calculated daily and compounds into a monthly payment. Even if the interest rate on your savings can’t top that on your home loan, it is sure to be higher than the balance transfer card you are using to pay off your credit card debt.

4 Save for your retirement

Regardless of any debt you have you should be thinking about your future and about building a retirement fund. Retirement savings accounts and superannuation funds have different tax rates and can make your contributions go even further, even if you are also directing some of your income to pay off debt. In saving for your retirement you can also take advantage of employer or government contribution schemes which will match your personal contributions up to a certain amount. Therefore, make personal contributions to your retirement savings up to this amount, get all of the tax and government incentives you can, and you can still focus on paying off your debt while sticking to a savings plan for your future.

There is no point in directing all of your income to pay off your debts if there is nothing put aside for the future. Therefore, don’t be in a rush to pay off your mortgage in lieu of saving for your retirement, because if you haven’t been contributing to your nest egg, it won’t matter that your nest itself is paid off.

Photo Credit: The Consumerist

Post from: Personal Finance And Investing

How to Save When You’re in Debt

Photo by: Chapek Sergey

Probably the most self-destructive thing that a person can do for their financial future is to pay undue attention to what those around them are doing.  Obviously this has limits, but using your friends, family or neighbors as benchmarks for “success” can manifest itself in many ways and almost all of them can sabotage your financial progress.  You should always remember that what a person presents as their situation can be very different from their true situation.  Let’s look at some ways the Joneses can sabotage you.

Status Symbols

Typically when talking about “keeping up with the Joneses” we’re referring to buying status symbols.  Maybe your neighbor bought a new BMW, and it sure looks nice.  Or maybe you’d like to host the football watching party sometime, but your TV just doesn’t match up to your friends’.  These types of situations can inspire us to make purchasing decisions that may provide a short-term high for a lot of pain.

Almost all status symbols are depreciating in nature.  Your car and that new TV are going to lose their value over time.  The more purchases like that you can avoid the better your financial future is going to be.  This isn’t really very tricky, and most of us are aware of this, even if we don’t always follow through.

Debt

Debt is a less obvious way in which our neighbors and friends can influence us.  The Joneses can convince us that it’s reasonable to carry credit card debt or car notes.  The Joneses can also convince us that it’s perfectly reasonable to stretch our budget to make these payments.  When you use debt to finance the status symbols, the damage is multiplied.  Carrying debt for an investment like an education is one thing, carrying it for a television is quite another, especially given the kinds of interest rates credit cards charge.

Risk

One of the most insidious and pervasive ways your acquaintances can affect your financial future is by affecting your investment choices.  This is in many ways one of the driving forces of asset bubbles.  Take the dot-com boom and bust.  You neighbor might have bought a stock and is now making 50% per year on it.  He’s telling you you’re a fool to stay out of this market.  You know that those kinds of returns aren’t sustainable or realistic, but it seems like everyone else is reaping them.  Maybe it really is a new economy and you’re the only one being left out.  So of course you join in the bubble just in time for the bust and get the worst of it.

Letting other people’s returns affect your investment decisions is very dangerous.  When it comes to investments we seem to suffer a form of mass insanity.  Look at all the people buying houses with no money down and interest-only payments because everyone knows house prices always go up.  Deep down everyone knows there’s no such thing as a free lunch, but when it seems like everyone else is getting one, we can start to make very bad decisions.  It never pays to abandon your own principles just because the Joneses seem to be beating the system.  The system has a nasty habit of catching up with the Joneses.

Post from: Personal Finance And Investing

The Joneses Are Your Enemy

Photo by: fairlightworks

The typical American is leveraged.  They have borrowed money to buy things.  This is not necessarily bad in and of itself, but if you start to think of your household as a business, you may stop and question whether the leverage you’ve taken on makes sense.

What is Leverage?

Leverage is the use of debt to magnify the outcome of an investment.  Say, for example, you are a company, and you trade widgets.  On each shipment you can buy widgets in one location for $10 and sell them in another for $12.  If you only had $100, you could only do this in shipments of 10 widgets and make $20 per shipment.  However if you could go and borrow $10,000, you could buy shipments of 1000 widgets and make $2000 per shipment.  Even after you paid back the party that loaned you the money, along with any interest, you would have made considerably more money per shipment.

Appreciating Assets

One of the most compelling reasons for an individual to leverage themselves is to buy an appreciating asset.  An appreciating asset is one that gains value over time.  The most common form of this in recent history has been real estate.  Leverage, in the form of a mortgage, is very common for an individual buying a house.

Even though the individual is paying interest on the money he’s borrowing, the house will (hopefully) appreciate in value at a rate exceeding the interest paid.  Thus, you might buy a $100,000 home with $10,000 down and a $90,000 mortgage at 7 percent interest. If you only paid the interest every year, you’d pay $6,300 in interest; but if the house is appreciating at 8 percent per year, you’d be making $8,000 – $6,300 = $1,700 per year after the financing fee.  In this case you’ve levered your $10,000 up to make a tidy profit.

Depreciating Assets

While we can never know for sure if an asset will appreciate, housing can be a fairly safe bet since it also provides a basic need.  Even if your house does not appreciate enough to offset your interest, you are also getting a place to live in the deal.

Unfortunately we also typically leverage ourselves to buy depreciating assets, or assets that lose value.  Most of us buy a car with a car loan.  As soon as we drive the car off the lot it begins losing value.  Meanwhile we’re also paying interest on the money we borrowed to buy the car, so we’re losing money in two ways.  While we can’t guarantee our house will gain value, we can nearly guarantee our car will lose value.

Shaping Your Thinking

You should start thinking of your life like a business when it comes to leverage.  While it might make sense to borrow money to buy a house, does it make sense to borrow money to buy a car?  Even worse, does it make sense to use a credit card to buy a flat screen television?  At least the car provides a necessary function.  You should assess what kind of assets you’re buying when you’re spending your money.  Things like education may be worth putting yourself in debt since they have the capacity to increase your earnings.

Ultimately the wisdom of a leveraged purchase should be viewed in light of two things:  The likelihood of it appreciating and the utility of the purchase.  The less likely an asset is to appreciate in value, the less likely you should be to incur debt to finance it.  It makes you wonder why so many of us incur debt to purchase something that can’t possibly appreciate and serves no important purpose.

Post from: Personal Finance And Investing

Should You Ever Leverage Yourself?

Everyone knows what you need to do if you want to get out of debt and create a savings account; you have to make more money than you spend. So if we all know this, then why are so many of us still in debt? If you’re still spending more money than you’re earning then it’s probably because of one of the following reasons:

• You don’t know how much you spend. It is shocking how many people there are who don’t track their spending. If you don’t know what you spend, you can’t be sure you’re spending less than you’re earning. Tracking your spending is the best way to avoid this problem. In rare cases, people don’t even know what they earn; tracking your income is also necessary.
• You don’t budget. Some people know what they’re spending. They know it’s more than they can afford. But they don’t budget so they only see the problem after the fact. Create a budget that relies on spending less than you earn. Then learn how to stick to that budget.
• You justify “emergency” expenses. The problem is that there are “emergency” expenses every month. You justify over-spending because you “need” to take the cat to the vet, get your home cleaned since your parents are visiting, buy a birthday present for the party that your child was just invited to, etc. Stick to your budget unless there’s a true emergency.
• You expect instant gratification. You want what you want when you want it. You’re willing to spend money to get it. If you want more than your income allows for then you’re in trouble. Learning to delay gratification until you have the money in hand to pay for what you desire can go a long way towards getting you out of debt. It’s also a great sign of maturity!
• You don’t know what you really want from life. People who know what their goals are can live in a way that allows them to achieve those goals within their income. If you don’t know what you want then you may spend money willy-nilly to try to find happiness in life.
• You haven’t dealt with your money issues. People spend money for a lot of reasons. They want people to like them. They want to show off. They want to buy whatever the neighbors have. They feel an emotional high when they spend money. If you haven’t dealt with your emotions around money then you might be overspending because you don’t understand why you spend. Deal with the real issues and the debt may disappear.
• You don’t earn enough. This is the biggest excuse that people use to explain why they’re still in debt. The truth is that you need to adjust your spending to your income. However, there may be times that you face this problem anyway such as during a bout of unemployment. Creating passive income streams, taking on second jobs or earning extra money by consulting or teaching are ways that you can help combat this problem.
• You’re just used to it. You may complain about your debt but if you’re not doing anything to change your spending then it may be that you’re just used to being in debt. Ask yourself if you want to maintain this habit forever.

You already know what you need to do to get out of debt. What problem is causing you to still spend more than you earn?

Guest post by Kathryn Vercillo. Kathryn is a writer for Promotionalcodes.org.uk which gives away online codes (like this La Senza promotional code) and also publishes a save money blog.

Post from: Personal Finance And Investing

Why You Spend More Than You Make (and What To Do About It)

People get into debt in a variety of ways.  Some people have medical problems or other things that are largely beyond their control.  Others have simply traded their future earnings for current creature comforts.

While the ways in which people get into debt are varied, the ways out really aren’t.  A lot of people try to make debt reduction complicated.  It isn’t.  There are a few basic moves that will get you out of debt, but they’re predicated on being realistic, accepting that you’ve already had more fun than you’ve earned, and it’s time to redress the balance.  Even if your debt is the result of things beyond your control, here’s some basic advice for those who feel like it’s time to be realistic about how to get out.

Cut Your Expenses

So you have a certain standard of living you’d like to maintain?  Too bad.  When you’re in debt, every dollar you spend costs you that dollar, plus all the financing costs until all your debt is paid off.  Let’s take a simple example.  If you have a 20% APR credit card and it’s going to take you 3 years to pay down your debt, every dollar you spend is actually costing you over two dollars.  That’s without taking into account the fact that a penny saved is more valuable than a penny earned after taxes.  That five dollar burger is now going to cost you ten dollars.  While this ignores the effect of inflation, you get the point.  Putting that dollar towards debts was the better move.

Get a Second Job

Many people are very concerned about their free time.  If you have debt, you’ve already spent your future free time.  When you bought that flat screen TV on your credit card, you were trading your future free time for a TV.  Doesn’t seem like such a good trade now?  Imagine the impact of another twenty hours of work on your ability to pay off your debts.  Assuming you’re at least in the black and slowly paying down your debts, you can put every penny you make at your second job toward your debts.  While you’ll lose some free time, you’ll reduce the stress that all that debt is putting on you.

Sell Some Stuff

This never seems to occur to people.  They usually look at that $250 duvet cover and think if they sell it for $75 they’re losing $175.  The simple fact is that when you sell it, you’ll get $75 on which you don’t have to pay taxes, and which you can apply immediately to your debts.  In our example from before, with 20% APR and a 3 year pay off window, that $75 will have saved you another $75 by the time your debt is paid off.  That means you didn’t lose nearly as much as it seemed when you sold it.

Don’t Get Too Sold on Emergency Funds

This probably isn’t your fault.  Right now all the talking heads on TV are telling everyone to worry about having an emergency fund.  They advocate making sure your emergency fund is well stocked before you start paying down your debts.  I think there’s some merit to this, but there are a lot of other considerations:

Your credit card can be your emergency fund. Assuming you are below your credit limit every dollar you pay towards your credit card can be used to pay for things later on if necessary for an emergency.  If you can get a cash advance then you can even use it to pay things like rent or other things that require cash.  There’s a small risk that your credit card company will reduce your limit, but if you’re being wise that risk is diminished.

While I can empathize with the importance of an emergency fund, try to keep it as low as possible.  It’s a very questionable decision to be paying 20% APR on your debts, while you have cash earning 1% or less in a standard savings account.

Make More Money and Spend Less

Ultimately getting out of debt revolves around this one simple formula.  Spend less, earn more.  That can be daunting–and easier said than done.  At the end of the day however, that’s what you’re going to have to do; so it’s time to get out there and show some hustle.  Grit your teeth and get your debt paid off as quickly as possible, and then look at all the finance charges as an education expense, since you won’t let yourself get in that position again.

Post from: Personal Finance And Investing

Debt Reduction for the Willfully Stupid

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The mortgage crisis was clearly one of the dominating catalysts of the recent economic fiasco.  While many other factors contributed, this was one of the most visible and visceral to most people.  Thus many people, particularly homeowners, are now wondering whether they can breathe a sigh of relief.

How Did We Get Here

By now we’re largely aware of the underpinnings of this crisis.  Demand for securitized debt led to tremendous demand for mortgages.   This demand led to lowered lending standards, which led to tremendous demand for housing.   The demand for housing led to soaring housing prices.   When those with the least capacity to pay their loans, who incidentally had the most onerous terms to their loans, couldn’t make their house payments, the whole house of cards came down.  Foreclosures led to dropping housing prices, which led to more defaults, which continued the cycle.

The Subprime Crisis

During all of this we were told the mortgage crisis and the subprime crisis was one and the same.  Many people equate the end of the subprime problems with the end of our troubles in general.  This leads us to wonder if the subprime crisis is truly over.  Signs suggest that this is the case.^[1] After huge surges, the default rates on these loans have come down sharply, leading many to suggest that the crisis is over.  Of course, that depends on which crisis you’re discussing.

The Real Crisis

Subprime loans may very well be dropping in their defaults, however that statistic neither creates an increase in demand nor says anything about the impending wave of defaults in other types of mortgages. Falling home prices put everyone underwater increasing the chance of defaults across the board.  Although many people who bought houses during the boom bought them with subprime loans, many more did not.

Defaults lead to a vicious cycle.  The owner of the mortgage immediately wants to sell the property, which increases supply, which lowers prices, which leads to more defaults.^[2]  Given that the subprime section of the crisis seems to be subsiding, the question becomes:  What makes us think this process is not about to repeat itself?

Option-ARM mortgages are currently getting a lot of media attention.^[3]   These are loans that have a low introductory payment, however over time that rate can be adjusted.  While Option-ARM mortgage holders may not be as likely to default during their introductory period, when their rates go up and they’re already underwater default rates are sure to climb.  While many stories are currently in circulation about this segment of the market, it small compared to Alt-A and Prime mortgages.

While the Option-ARMs may further the cycle this cycle seems sure to repeat in Alt-A and Prime mortgages as well.  Even though these loans were made to fairly safe lenders, due to the crash, they frequently owe more than their house is worth, are possibly out of a job and very likely facing a weak housing market.  If we look at Alt-As by vintage, we see soaring rates for those made in later years. ^[4]Prime mortgages with similar vintages see a similar curve, just starting later.  With all of this evidence and the relative size of the markets, it seems highly premature to suggest the worst is over.

Post from: Personal Finance And Investing

Is the Mortgage Crisis Over?

1. Deutsche Bank – Subprime Chart
2. Wall Street Journal - How to Help People Whose Home Values Are Underwater
3. Reuters - Option ARMs, next chapter in U.S. housing crisis
4. Standard and Poor’s - The Spotlight’s On U.S. Alt-A RMBS Issuers As Performance Deteriorates Rapidly

Photo by: Vinay Deep

For decades now the American approach to debt has been to worry about it later.  We’ve essentially kicked the problem down the road.  While some points in our history may have suggested somewhat higher debt levels, we’ve done nothing to reduce them in more booming times.  Ultimately we’ve just turned a blind eye to a growing problem and it may be too late. 

Many people are talking about moral hazard these days, but strangely they all seem to think it’s something that applies to someone else.  Bailouts of millionaire bankers strike us as outrageous, while we personally hold an absurd amount of debt.  Somehow the country got all screwed up without any of us being at fault. 

Our politicians seem to suggest that their opponents are the ones rewarding negative behavior and that they themselves would never commit such an act.  This doesn’t hold up to much scrutiny however.  Throughout the booms of the previous decades, neither Democrat nor Republican has ever used fiscal policy to “cool down” a boom.  Nor have they used any of the booms to reduce our debt to increase our capacity to deal with the next bust.

Clinton was just beginning to talk about reducing the debt when the Internet bubble burst.  Bush managed to go through a massive housing bubble while growing the national debt by over 4 trillion dollars.^[1]  Government has simply never shown any discipline in managing its budgets.  Unfortunately, this is not only true of the government.

Short Term Myopia

Americans and people in general have a tendency to look at a very short sample space and assume that the results they’re seeing are meaningful.  Ten years is a long period of time in a human life, so if something has held true for the last decade, it must be true, the thinking goes.   Unfortunately those ten years are actually quite a short time in the life of an economy.

So many times in history we’ve been told that “things have changed.”  Something has fundamentally shifted and the old rules don’t apply anymore.  For the last decade, people watched their 401(k) accounts grow by double digit figures each year and they just came to assume that this was a sustainable result.  Similarly they’ve leveraged themselves to the hilt and assumed that since they’ve been able to sustain themselves with this massive debt they’d be able to do so in the future.  Sadly, this is an untenable ponzi scheme.

Total Credit Market Debt

Since the introduction of the credit card, Americans have developed a taste for debt.  As the National debt has grown over the past decade, household debt has skyrocketed right in step.  Total credit market debt has gone from roughly 1.5 times GDP in the 80s to over 3 times GDP today^[2].  This means that we essentially owe more than three times in debt what the country makes in a year.  With GDP likely to fall in the near term and massive government spending, this situation is unlikely to be corrected.

As we’ve been growing this debt in the personal sector, the financial sector and the government sector, we’ve been assuming we’ll straighten it out in the future.  And many people haven’t thought about it at all.  Fundamentally we have to know that we’re making bad decisions, but everyone else is doing it and it hasn’t turned out badly for them. 

For decades now we’ve been growing the problem and pushing the problem into the future; each time we postpone a solution, the eventual bill to pay becomes more and more grim.  We continue rewarding the people who make bad decisions and punishing those who don’t.  We never want to take the short term pain, so we reinforce the moral hazard and hope that sometime in the future we’ll come up with a magic solution to the monster we’ve grown over the past decades. 

Ultimately all we’ve been doing is saving up pain.  For a while it looked like we’d finally have to take our medicine when the credit crisis hit.  But through stimulus and unprecedented government action it seems like there is a possibility we’ve pushed off the reckoning a little longer, making it all the worse in the process.  The only question is: have we already run out of rope with which to hang ourselves.

Post from: Personal Finance And Investing

Debt and Moral Hazard

1. CBS News - Bush Administration Adds $4 Trillion To National Debt
2. Comstock Funds – Total Credit Market Debt

Photo by: House of Sims

While I run the risk of alienating a lot of low-carbers out there, I’m choosing to use Atkins as an analogy because I think there are a few parallels between the diet and my reluctance to endorse the debt snowball approach that is currently en-vogue. Generally the accepted science on Atkins as of this writing is that while it is very effective at weight loss, the long term benefits are not entirely clear^[1]. This largely equates to why I don’t advocate the debt snowball approach.

What is a debt snowball?

For those who aren’t familiar with it, the debt snowball approach is a fairly simple idea. Advocated by popular finance adviser Dave Ramsey, the basic premise is that instead of paying off your highest interest rate debt first, you should pay off your smallest balance first^[2]. The thinking behind the idea is that by “knocking off” debts as quickly as possible, you build momentum. This momentum gives you a sense of accomplishment and helps you persist in changing your habits. While purists may take me to task on the details, I believe I’ve captured the essence of the method.

My Initial Resistance

Ultimately my first problem with the approach is the obvious one: You are not increasing your net worth as quickly as possible.

I think this issue is completely relevant, but ultimately not very compelling. However for the sake of argument allow me to present a hypothetical situation which makes I think a strong anecdotal point. Suppose you have a variety of debts that add up to $7,000 with a monthly interest rate of 5% and a $10,000 debt with a monthly interest rate of 10%. Now also assume you are paying $135 per month towards your debts. If you use the snowball approach and pay down your lesser payment, your total debt would be going up very slightly, while if you paid your higher interest rate debt down first, your total debt would be going down slightly. ^[3]

What’s particularly interesting however, is that by the end of one year using the debt snowball, you would see a significant improvement in your lower interest rate debts. You would have paid your smaller debts down by considerably more than you would have paid your higher interest rate debts back. It intuitively looks like you’re in a better position. Thus you stay motivated and keep paying down debt because it looks like you’re making progress. In reality you’re actually losing ground. To be fair this is a fairly contrived example and in most cases you’ll make headway either way. But that brings me to my real objection to the debt-snowball.

Tricking Yourself vs. Learning Principles

Ultimately what troubles me about the debt-snowball is that it’s basically a way to make yourself feel good instead of actually learning the financial principles. This troubles me in the same way that the Atkins diet does. You can learn a set of rules that allow you to see what you perceive as progress, but ultimately if you vary from the plan you haven’t really learned the tools to do anything else and you may experience a “rebound.”

When it comes to debt, if I’m relying on how I feel vs. learning to feel better about what is in reality the best course of action, then I’m not really learning how to be financially wise. In fact isn’t this sensation what gets people into debt in the first place? Isn’t the notion that it feels like you own those things, even though you haven’t paid for them that gets you in trouble. So I’m not sure that advocating a plan that feels like you’re being responsible even though there’s a preferable approach is the way to go.

Maybe I’m unrealistic and some people just can’t learn basic finance. I’m also fully aware of the power of behavioral learning so I’m not rabidly opposed to this approach. It just seems to me that maybe, much like Atkins, this isn’t a fix-all for an age old problem. It may be a convenient way to get people to see results, it may not be the best in the long run.

Post from: Personal Finance And Investing

Is the Debt Snowball an Atkins Diet?

1. “Atkins Diet Vindicated But Long-term Success Questionable.” Obesity, Fitness and Wellness Week — June 14, 2003: 25.
2. DaveRamsey.com – Debt Snowball – The Truth About How to Get Out of Debt
3. This assumes you have no minimum payments and can pay all of your payment to one debt. It also makes certain assumptions about how interest is calculated, but it is just a demonstrative hypothetical anyway so settle down.

Photo by: SqueakyMarmot

This post is step 1 in our Investing Template.

Deciding when and how to pay off your debts is not a simple matter.  While it can be comforting to be debt-free, that may not always be the most financially expedient approach-nor is it the whole picture. Here are a few steps, including analyzing and paying off debt, that really make your money work FOR you.

Step One: The Basic Emergency Fund

The absolute first thing you need to have is something to pay for unforeseen events.  I personally recommend keeping this fund as small as possible at the beginning.  We’ll get to creating a larger cushion later, but right now the goal is simply to get enough money so that you’re covered if your car breaks down or something else untoward happens.  In fact, in some cases I’d recommend skipping this step altogether.  If you have friends or family you believe you can reliably rely on in case of an emergency, get right down to paying off any debts.  Once your debts are paid off, go on to creating an expanded emergency fund.

Step Two: Minimum Payments

Paying off your debts is one of the best investments you can make, but it isn’t always the best.  You need to take a lot of things into account to decide when and how to pay off your debts, and the analysis isn’t always simple.  One main rule is this:

Always Pay Your Minimums

You cannot possibly hope to match the interest rate you will be charged with late fees and penalties, so you have to pay at least the minimum to every debt you have.  So no matter what other options are open to you, do not let yourself be subjected to these kinds of charges.  If you cannot meet your minimum payments, it’s time for another job, or to sell some things.  Getting your head above water is a separate subject, but make sure to do it.

Step Three: Tax-Deferred Options

Now despite the allure of being debt-free, there are some rare occasions that your bottom line will be better served by contributing to your tax-deferred savings.  Quite simply, if your company matches your tax-deferred account at 50% or better, you may be better off contributing to that account.  This is of course only true up to the amount that they match. Do not contribute more than they match until your debts are all paid off.

For example, if my company will match up to 3% of my salary in my 401(k) at 100%, I am possibly better off making this contribution instead of paying off my debts.  I will make 100% return on that money put into my 401(k), while I will probably be charged 20% on the debts I leave unpaid.

Generally speaking however, unless your debt is relatively small compared to your income, or you are very secure that your income will continue, you are probably still better off just paying the debt.

Step Four: Pay Off Your Debts

There is no sense investing in anything when you have the option of paying off your debts.  The only debt you may want to carry is a house or a car, and even those are questionable.  Even beyond the dangers of high-interest debt, it simply provides a security blanket to have your debt cleared.  There are various approaches to paying off your debt, but get it done before you start investing your money elsewhere.  Moreover, when in doubt: pay off your debts sooner than later.

Post from: Personal Finance And Investing

Investing Prerequisite #1: How To Deal With Debt