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The Dirty Secrets of Debt Reduction (and What to Do About Them)
Thursday, 17th July 2008 (by J.D.)This article is about Debt, Money Hacks, Psychology, Real-Life
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When I was a sophomore in college, I got my first credit card. I thought it was awesome — it was like free money. Soon I got another credit card, and before long I’d maxed them both out. I entered the work force with a handicap. I had the start of a nasty credit habit.
Because I’d grown up in a poor family, I had no notion of proper money skills. I made some bad decisions, which were in turn compounded by some rotten luck. Just five years after graduation, I had about $20,000 in credit card debt. For ten years, I tried to kick the habit. Sometimes I’d make progress, but then I’d find other ways to fall behind.
Here are some of the mistakes I made along the way and the steps I took to correct them:
I had no goals
When I was young, retirement seemed like something for old people. I did not understand the power of compound interest, that starting to save for retirement when I was 24 was far better than starting when I was 39. But more than that, I failed to set financial goals. I didn’t dream of taking a trip to Europe. I didn’t plan big purchases. If I wanted something, I bought it. On credit.
Eventually I realized the only thing that the only person who cared about my money was me. I set a goal: be out of debt within five years. You know what? The very act of setting this goal made a huge difference in my life. Suddenly, my money had a purpose. I focused my efforts on debt reduction. I didn’t get my debt paid off in five years — I paid it off in three.
I didn’t establish an emergency fund
Many financial experts recommend starting an emergency savings account before you begin to pay off debt. I was arrogant. I believed this advice didn’t apply to me. But then my car broke down and I needed to make $800 in repairs.
Because I didn’t have an emergency reserve, I was forced to open a credit account at the dealership to pay for the repairs. This debt felt terrible. (It would have felt even worse if I’d put it on an existing credit card.) I paid it off as soon as possible, and then paused my debt elimination plans for a few months in order to stash $1,000 in the bank.
I didn’t track my spending
One reason I was able to get so deep into debt was that I didn’t track where my money went. It was like a black box. I just spent to my credit limit. Once I started tracking my spending in Quicken, problem spots became obvious. By tracking every penny I spent, I had a clear idea of how much I was actually earning and spending, not just vague guesses. (If I were starting now, I might use a web-based tool like Wesabe or Mint or Yodlee or Quicken Online.)
I tried to pay high-interest debt first
Most of the financial gurus give the same advice about debt reduction: eliminate your debts starting with the highest-interest rate obligation first. This makes sense mathematically, of course, but what these experts fail to understand is that debt isn’t about math — it’s about mental mistakes. If debt were about math, nobody would have it.
For years I tried to pay off my high interest debts first, but I’d always give up. My high-interest debt had high balances, and it felt like I was never getting anywhere. Then I read about Dave Ramsey’s debt snowball. Using this method, you pay off your lowest balances first. This allows you to knock out a few debts right away, which gives you a tremendous psychological boost. Once I learned about the debt snowball, I was able to kick debt to the curb.
(Another valid approach is to first pay off the debt that bugs you the most. Have a loan from your brother-in-law that you feel guilty about? Pay that off before anything else.)
I led myself into temptation
I like comic books. I’ve collected them since I was a boy. As an adult, I discovered I could pay $20 or $30 or $50 each for bound volumes that collected many comic books at once. I have a weakness for these books.
When I started to pay off my debt, I kept going to comic book stores. “I’ll just look,” I’d tell myself. But the thing is, I didn’t just look. I bought. Every time I set foot inside a comic book store, I’d leave with a book or two. Comic books were my kryptonite.
Your kryptonite might be bicycling gear or yarn or shoes. Whatever it is, avoid it. If you know you have a weakness, steer clear of situations likely to make you spend. Remind yourself of your goals.
I treated mistakes as if they were the end of the world
Nobody’s perfect. I made mistakes all the time as I was paying off my debt. As I mentioned, I’d sometimes find myself buying comic books, or spending $80 on expensive bottles of Scotch whisky. When I was starting out, I’d let these mistakes get me down. I felt like they derailed all the work I’d done. But that’s not true.
Paying off debt is like playing baseball. You go out there and do your best every single day. You follow the fundamentals. If you make an error, you don’t give up — you make the play next time. If you strike out, you forget about it and step to the plate for your next at-bat.
I spent raises and windfalls
I used to view raises and tax refunds as a license to spend more money. $1200 back from the government? I’d use it to buy a new bike. A new raise at work? Time to subscribe to more magazines. Or maybe I can afford that deluxe cable package. I was succumbing to lifestyle inflation — as my income went up, so did my spending.
After reading Your Money or Your Life, I realized that the smart move wasn’t to increase my spending, but to decrease it. I cut magazine subscriptions and cable television. Instead of spending my tax refund, I applied it directly to debt. Sure, it would have felt nice to buy a new television, but it felt even better to say good-bye to another credit card.
I didn’t seek help
Like an alcoholic, I hid my habit. Maybe “hid” is too strong a word, but because Kris and keep separate finances I was able to hide my debt problem from her. (This is one of the drawbacks to such a system — there are drawbacks to joint finances, too.)
I knew I had a spending problem. I knew it intellectually, and I could feel it in my gut every time I bought something with a credit card. But knowing you have a problem and doing something about it are two very different things.
About five years ago, a friend heard me complaining about my situation. He didn’t scold me. He didn’t moralize. He just gave me a book (the aforementioned Your Money or Your Life) and suggested I read it. I was lucky. Though I didn’t seek help, help eventually found me. I could have saved thousands — tens of thousands! — by admitting I had a problem early on.
(Debtors anonymous was made for people like me.)
The final secret
The biggest secret of debt reduction? Getting rid of it feels awesome. After living in debt for twenty years, I’ve spent about eight months debt-free. The sense of freedom is euphoric at times. Psychologically, I’m a new man.
The thing is, most advice about getting rid of debt is purely theoretical. It’s written by pros in suits who think that debt is all about crunching numbers. It’s not. If smart money management were just about math, everyone would be rich.
But smart money management is mostly mental. It took me a long time to learn that. Once I figured that out, I felt okay ignoring the advice from the “experts”. I learned to play mental tricks on myself. That’s what helped me get out of debt.
Thanks to Leo at Zen Habits for the original idea for this article. It was intended be a guest post at his site while he was on his honeymoon, but I didn’t get it pulled together in time. Instead, I contributed a “best of GRS” article: How I paid off $35,000 in debt, and how you can too. Photo by Dan Esparza.
73 Responses to “The Dirty Secrets of Debt Reduction (and What to Do About Them)”
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July 17th, 2008 at 5:20 am
I went out on New Year’s with some (several times removed) friends a few years ago. I was appalled at the entry price to the club ($50), I was appalled they would order Grey Goose and a few other fancy drinks ($800), and I was appalled they were going to put it on their _mom’s_ credit card. I left right after the ball dropped before they could do any damage to me.
July 17th, 2008 at 5:42 am
As someone just starting out on getting rid of her debt ($20,000 in mostly student debt), I’m encouraged by your post (and blog as a whole). I’m glad that I’ve already started an emergency fund and tracked my spending, but I’ve got a long way to go. I’m going to reserve that book at the library and hopefully, that’ll help prevent me from being discouraged.
July 17th, 2008 at 5:48 am
Spending money is so easy and fun, but the moment your bank account starts to feel the heat, you begin to have feelings of guilt.
Why did I spend a lot of money on that thing that I don’t really need? When my first baby was born, I said to myself: I should start paying more attention to unnecessary spending. When you feel responsible to your child, you begin to notice that it’s time to be more careful and to calculate your spending.
July 17th, 2008 at 6:03 am
That is a great point Joel. A baby or other life changing events can really put into perspective what really matters. I had a friend recently tell me that he looks at what a dollar is worth to him. He has to work 5 minutes to make that dollar. It makes it easier for him not to spend that money thinking of that.
July 17th, 2008 at 6:13 am
Great post. One of the things that caught my attention though was something you mentioned off-hand: the fact that you and Kris keep separate finances. Now, I am not married myself, but I have always wondered about the couples who kept separate finances. I guess since that is what my parents do, it just seems like the natural way to do it. This could be a good idea for a post in the future: the pros and cons of separate vs. combined marital finances.
July 17th, 2008 at 6:55 am
Your leading statement of the second paragraph intrigues me, “Because I’d grown up in a poor family, I had no notion of proper money skills.”
What is the line between rich and poor? Is it a dollar figure or state of mind?
The flip side of that statement would seem to suggest that if you grow up in a rich family you will possess proper money skills. I think we all can agree that is NOT universally true.
I think the line between poor and rich is more about whether or not you are living within your means and your level of contentedness.
All I am suggesting is that you can obtain/have proper money skills regardless of your parents’/your income level.
Thoughts anyone?
July 17th, 2008 at 7:00 am
In response to Jen’s desire for a post on the pros and cons of separate vs. combined marital finances…
Which Should You Choose: Joint or Separate Finances?
July 17th, 2008 at 7:02 am
Doh, didn’t think to check the archives. Thanks Noel.
July 17th, 2008 at 7:17 am
Noel is right. He’s absolutely right. People raised poor can have good money habits. And there are plenty of people raised rich who do not. I should have made that clear.
In my case, however, I had absolutely no concept of how to manage my money because I’d never seen smart money management modeled. I learned about business ownership, but I also learned how to spend everything I earned. Mom and Dad did their best, I’m sure, but ultimately all three of their sons have struggled with money because they didn’t have a sound introduction to the subject.
July 17th, 2008 at 7:20 am
Oh my…it sounds like you’ve been in a lot of trouble previously. Well, thank God you are out of it and got your life straightened out!
Evelyn
July 17th, 2008 at 7:35 am
I grew up in a comfortable, middle class family. We didn’t have to struggle, and we always had our needs met. However, my parents overspent and had significant debt (from what I could tell at the time). There was no concept of spending less than you earn. The result is that I learned those money-management skills, and now find myself in debt, too.
Note: I am not blaming my parents for my poor financial decisions. I am just saying that my first lessons about money were unhealthy ones.
July 17th, 2008 at 7:50 am
One of the biggest revelations that my wife and I have made has been to not listen to what everyone says about paying off the high interest cards first. We have started the snowball method and it works brilliantly! We’re actually getting somewhere. Do what works for you.
July 17th, 2008 at 8:03 am
This is a *great* article. I always find motivation and inspiration from “real people stories” and not just what the “experts” say. I can totally relate to your background, as I fall into the same boat and I have made some of the same mis-steps that you have listed. I am ready to move forward and need to find ways to “drink the Kool Aid” as Dave Ramsey says…as we just haven’t yet. We’re going through a bit of a tough time financially and emotionally with a job loss and are struggling on how best to move forward. Articles like this (and comments about how having children changes your perspective, for example) are the push I think I need to better commit to the principles I KNOW can help overcome our debt. It’s too bad just believing in something isn’t always enough to encourage you to make the “right” decisions (which are often not the easy ones).
July 17th, 2008 at 8:07 am
These are some great tips. I have been very fortunate, my parents taught me money management skills at a young age (my mom being a banker helped). I barely ever use credit cards (only a couple times a year, on big purchases like vacations) and I pay them off when the bill comes. Actually, the only reason I use the cards at all is so I can keep my credit high. If possible I like to use cash for everything, or at least my check card.
July 17th, 2008 at 8:36 am
Great post J.D.! I’m going through much of that myself now, and I hope to one day soon experience that euphoria of knowing that I am successfully debt free. I’m at the beginning of my trek, but feeling good about it.
The most important point you made? About not beating yourself up when you make a mistake. Try, try again. It’s the only way to success!
July 17th, 2008 at 9:10 am
Great post. I am interested in yours and everyone’s opinions about aggregation services like yodlee, mint, and wesabe, mentioned above. I did some reading on each of the sites, and my security concerns weren’t really abated. To clarify–you have to put all your bank account info on these sites. I’m hesitant to even buy things with my c/c online. Any thoughts?
July 17th, 2008 at 9:44 am
I have plenty of silly addictions that waste my time and money. But I don’t get comic books.
What do you do with them? Do you actually read the comic books? Just look at the pictures? Just collect them?
July 17th, 2008 at 10:03 am
I “snowballed” all of my debt into one 0% balance transfer offer on my credit card. I had to pay transfer fees, but they came out to be significantly less than what the original interest rates would be. When my balance transfer rate expired, I transferred the balance to the next lowest rate balance transfer offer. I did this for the better part of 3 years. Unfortunately, finding 1.99% or less balance transfer rates has all but disappeared these days. Fortunately, I paid off all my debt in February this year before the credit card companies started getting really nasty with this “trick” by removing the transfer fee cap.
July 17th, 2008 at 10:22 am
I cannot believe the mental acrobatics people will go to in justifying ’snowball’ debt reduction schemes, but the “it is good psychology” excuse bugs me the most.
Instead of using ‘good psychology’ to enforce a bad habit, use the good habit (ie: paying off in the optimal order) and if you really need it come up with some system to enforce the good habit.
Try drawing a poster. Chart a line “where I am now in my debt reduction”. Draw another line “where I’d be if I’d fallen for that Ramsey drivel and not been paying down the high interest debt first”. Watch the lines diverge.
Or, if you’re stuck on doing it the Ramsey-way then you can draw a different sort of poster. That poster could say things like “I’ve given this much extra money to my creditors SO FAR!” and “Because I can’t effectively manage my finances I’m going to be in debt an extra N months!”
July 17th, 2008 at 10:27 am
“If debt were about math, nobody would have it.”
No, no, no, no. The debt I have IS about math, and that’s WHY I have it.
I chose my debt to go to a school where I could get the best education in my field possible. It was crazy expensive. I financed it on my own by taking out loans and putting a lot of it on credit cards. I came out with $55K in student loans and $20K in credit card debt. I used this debt to get pretty close to my dream job. You know, that SL debt is at 3.75% and all the CC debt is now at 3.99%. The quote always sounds to me that having to pay any interest is foolish regardless of the situation. It’s totally wrong, and you HAVE to use MATH to figure out when to take on debt!! I make around $100K. As long as I contribute 10% of my salary, I get a 401(k) match from my company to the government limit (this year it’s $46K, last year it was $45K). I guess I should just hang myself for making such poor choices to take on any debt. God forbid, I also took out a small mortgage at around 6% to buy a place I really like (only 5% down but no PMI). I guess I should have never bought it either because I had to take on debt. The same goes for my car loan that’s at 2.99%. I don’t think it does any body a service to tell people to ignore the math and go on feelings alone.
Which would you choose, the math that puts me up about 300K in three years without being completely out of debt, or the feelings that I should give up my 401(k) match to be completely debt free in 3 years? It IS all about the math of the situation, and mine works out really well.
July 17th, 2008 at 10:29 am
There is another way to payoff debts that can be very useful sometimes and that is to pay off debts that require the lergest payments first. We had about $10k on a zero interest loan and $10k on a credit card at 9% or so. The loan required a payment of like $900/mo, but the credit card only $200 or less. Makes mathematical sense to put any extra money on the credit card and wait for the loan to be fully repaid in about a year. However, every time we had some extra money we would put it on the credit card which would then rise right back up. By paying off the zero0interest but high payment loan we now could use that money to focus on paying down the credit card and keeping it down.
July 17th, 2008 at 11:13 am
Richie, I think comics as a medium are undergoing a growth period in their creativeness, diversity, and literaryness (if that is a word ;)). It’s not just superhero stuff. Unfortunately the library only carries a fraction of what’s out there, so the only recourse is to buy it. To save on that, my husband has started an informal lending library with a couple of his friends, where they let him read the new stuff they have bought and he lends out a chunk of his older comics to them.
July 17th, 2008 at 11:20 am
It is always so encouraging to hear you tell stories of where you were and where you are now. I have learned myself that, just as you said, money management is mental.
I look forward to the day that I am out of debt and can feel that freedom. To know that no one owns me.
July 17th, 2008 at 11:41 am
oldmiter - Your point is well taken. Many loans are smart tools for someone with good credit who can get those interest rates. However, when you took out the loan, you had no guarantee that you would be in the strong position you are now. A friend of mine took out $100k in student loans to go to the best school for his field, and now works for $25,000/yr because he can’t find anything better.
I think the original comment meant that for the majority of people, taking on debt means that you don’t have enough money to pay for something but you buy it anyway. That is bad math. Of course it isn’t true in every situation, but I think too many people take on debt thinking that it will be very easy to pay off in the future when they have no guarantee of that.
July 17th, 2008 at 11:42 am
Hi-I subscribe to your blog but never comment. Just too busy most times, but I’m breaking silence here. Wow: this post *really* hit me right where I live right now, more so than any other post I’ve read here. Hearing you mention the EXACT pitfalls I’m experiencing and that you still got out of debt is so good to know. I’ve really been struggling with the saving $1k for emergencies. I ‘thought it didn’t apply to me’. TOTALLY. And now I get it. In the last year, I have reduced my debt a little (the total is less than it was last year), but I’ve eroded it nevertheless by being forced to use a CC when I had no cash in the bank and an emergency popped up. No More! And that goes for all the other things you mention here that I’ve waffled on. I’ve had it! I want to be done with the debt as soon as possible. Wish me luck. And luck to all the other readers/commenters.
Thanks JD.
July 17th, 2008 at 11:43 am
The comments on the post from the 3rd of July, Financial Success Stories for the Fourth, inspired me to take on my last chunk of debt head-on: I’m pillaging my travel & emergency funds to cut my student loans nearly in half (don’t fret, I’ve left 2k in the e-fund), and I’m going to hit them hard for the rest of the year. I can definitely get them paid off by next spring; I’m hoping to go faster than that!
It really IS about the math - I’d convinced myself that the loans were “okay” debt since they’re at a low rate, but I looked at my payments and realized fully 26% of my monthly payment is going toward interest - no thanks, Sallie!
So, thanks for the continued inspiration.
July 17th, 2008 at 12:17 pm
Wow, I am at the start of my debt reduction cycle and it’s great to read this type of article. As someone else said already it’s fine to hear what the experts say but true life stories are better motivators for myself. 20,000 in credit card debt seems like so very much. Makes my 4500 seem almost non-existent. One thing I would like to note though is your details about separate bank accounts. My wife and I got married earlier this year and until then we had kept separate bank accounts as well. But afterwards we created a joint account and have been working together on that. With us also having twins money has been very tight. Recently we went into the negative and that was the last straw for me. I couldn’t understand. I’m making more money than ever but we are still managing to spend it all. My wife took over the finances and discovered I’ve been making mistakes in our budget and now we are on the fast track to debt freedom. I’ve just been too busy with work to notice my mistakes. The biggest suggestion I have for people about getting out of debt is stay on top of your budget. Enter your transactions instantly or at the very worst case daily. My wife and I use google docs for our budget (as an excel replacement) so that no matter where we go we can quickly update the budget.
I am rambling. Anyways, great article as always. I have to remember to send my wife the link!
July 17th, 2008 at 12:26 pm
@LC
I get what you’re saying too. I think emotions come into play with finances when people delude themselves into thinking that everything will work out OK, they make no plans for contingencies, and just ignore their situation and get deeper in debt. It’s only after they get a real scare or hit rock bottom, that they get the personal finance religion. A lot of times, these people then go a little too off-the-reservation extreme for me, when it could have all been avoided by not discounting the math.
It would have been terrible for me to end up without a good job after my $75K in school debt, and it would have hurt pretty bad to have to pay that off with a low paying job. But after graduating, the first thing I did was to look for a job that I liked. It was hard, but I eventually got one. Only after that did I purchase the car (a Honda Civic, so nothing fancy). Only after ‘making partner’ (not exactly, but similar in my company/field) did I buy my condo. I’m trying to do the best I can for me, and it doesn’t always work out that way. I know not everyone has or wants to make so many tabs in their budget spreadsheet as I do to calculate the unexpected outcomes and what-ifs, but doing the math always helps me determine the best course of action. I strongly disagree when people close their eyes to its power or worse encourage others to do so as well, which caused me to respond the way I did in my first comment.
July 17th, 2008 at 12:29 pm
Why the venom for Dave Ramsey?
July 17th, 2008 at 12:50 pm
Greetings from a fellow Milwaukiean…just wanted to comment that a lot of what you described as obstacles to financial well-being either reflect or run parallel to my own experiences. Namely, growing up around all the worst examples of money handling and failing to overcome them, giving in to college credit temptation, having neither a plan nor any emergency money, and spending way too much time and money nurturing consumerist weaknesses. Only, instead of comics, my crack of choice were media…CDs, DVDs, video games, etc. I’ve finally put my fiscal foot down and am starting the long road back, and posts like these provide a lot of encouragement. Thanks!
July 17th, 2008 at 12:58 pm
@Richie “Why the venom for Dave Ramsey?”
Say you’ve got a Visa at 10% interest with a balance of $1,500. Now throw in a line of credit from Dell or whoever at 24% interest with a balance of $2,500. After cutting out the overpriced-steamed-milk-and-coffee let’s say you’ve got $100/month on top of the minimum payments ($15 and $25 let’s say). How much money are you going to waste on a snowball compared to taking down the high-interest debt first?
Now imagine how big that amount of wasted money would be for someone with more debt than that…
Now multiply that by the number of folks who bought in on Ramsey-style snowballs and tell me how much money Ramsey has helped the holders of these high-interest debts make.
July 17th, 2008 at 1:10 pm
What I am so excited about is that it is not going to take me 10 years to work out the things you worked out. They are right here on this page!
I am 20 years old and I don’t have a credit card and I believe that I can learn the skills now that you have been learning so I can become financially secure, rich and be able to retire early. So thanks for the post
July 17th, 2008 at 1:18 pm
I think it’s not just about being poor or rich, but about being involved in family money decisions.
My family was pretty well-off and my mom has great financial skills. Somehow, I didn’t seem to inherit them! When I finally got my act together, I had a large amount of debt.
July 17th, 2008 at 1:21 pm
Chris, while I respect your opinion, I think you’re missing the point. The advantage of the debt snowball is that it works. It doesn’t matter whether it costs a little more. People get their debt paid off with it. I did. So have many others. Did it cost me a few hundred dollars extra? Perhaps. But it cost me thousands of dollars extra to keep trying and keep failing with the high-interest first method.
There is no one right way to pay off debt. To argue that there is discourages people from using options that might actually work for them. Yes, the high-interest first method makes the most sense mathematically. There’s no denying that. But there are other methods that work, too, and have different advantages. The psychological advantages of the debt snowball are very, very real.
You believe that paying off debt using any method other than high-interest first is a “bad habit”. I would argue that paying off debt — no matter how — is a good habit.
Finally, while there is a cost to using the debt snowball, it’s not as big as you might believe. Trent ran some numbers last year, and concluded that there was maybe a 5% difference in total costs. I’ve seen several other studies that show the same thing. Is it worth a 5% premium for some people to actually get their debt paid off? It was for me, and for many others.
I think you do a disservice by declaring the debt snowball “bad”. It’s not. When I (and other personal finance writers) mention the debt snowball, we’re very clear to indicate that it’s not the most mathematically optimal method. We’re not trying to pull the wool over anyone’s eyes. What we’re trying to do is tell people there are options, and that if they’ve failed with the traditional high-interest first method, they should try something else.
July 17th, 2008 at 1:48 pm
One way I like to thing of time vs money is…
Spend money to save time; spend time to save money.
I use the eating out as the best example. I can eat out have a meal made for me and it doesn’t take a lot of time. The other side is I can stay same and make my own four course meal over 2 or 3 hours.
I can spend money to use someone elses time or spend my time to save that money.
It all depends on the preference though. It is still nice to eat out but its still money and its still time.
July 17th, 2008 at 2:09 pm
*There is no one right way to pay off debt.*
I have to disagree with this entirely. There is a right way to do it, or an optimal way, if you prefer. My personal feeling is that if you don’t have the willpower to truly make those decisions to do so, then you are committing the same lack-of-will that the ‘debters’/overspenders/etc are doing.
It’s like saying there is no right way to invest, when massive amounts of people would jump on anyone who says high fees are acceptable. It’s like saying that investing in GICs is a good tradeoff against stock market returns.
Simply track debt as a whole if this is really a concern. The chart will drop off fastest when you pay down the higher interest first.
As far as the 5% premium… well, what can I say? Is this any different than simply increasing your spending by 5%? Can’t hurt, right? (Well, ignoring that debt has an end to it, but anyway…)
July 17th, 2008 at 2:18 pm
“Because I’d grown up in a poor family, I had no notion of proper money skills.”
Not sure what you mean by this. Poor families can have very good money skills. They can make the very most of what they have, and still be poor.
July 17th, 2008 at 2:24 pm
My girlfriend used the snowball method and it worked great for her. She kept up with her other minimum payments and then started destroying her smaller debts.
She was so into it that she paid off a $400 credit card in little more than a month. She said that thinking about only one of her debts at a time made it easier to get excited about paying it off.
July 17th, 2008 at 3:08 pm
I just paid off my credit cards, and for the first time in almost 30 years I am debt-free.
Nothing but rent, utilities and the other monthly things.
So, when do the good feelings kick in? Seriously, I’m not getting a buzz from it.
It was a mistake to get that far into the hole, and all I did was fix the mistakes, and for that I’m suppose to feel like dancing?
July 17th, 2008 at 3:22 pm
Great post. Anytime you get such lively discussion, you know it’s a good post, JD.
I think money is all about emotions, whether it’s feeling good about paying off debts through the snowball method (a method we used years ago before Ramsey–just knowing we’d have less bills staring us in the face and could apply more to the remaining ones as some were eliminated), hating money, loving money, etc. I know Suze Orman gets dissed here a lot and I understand why, but her musings on how our feeling about money and how we’ve seen what money represents emotionally growing up makes a lot of sense. So it’s not whether your grew up poor, middle class, or upper class, It’s about whether money was feared, etc. PLUS, it’s about whether you actually got to earn and spend money and be responsible. That is huge. You can’t learn how to deal with money unless you do that. I did not do that until I was in college and I made the same mistakes others have made. And, as much as we look back and say “coulda, woulda, shoulda,” you really only learn by experience and you only change when you are ready–whether it’s managing money, losing weight, etc. And, I have to be honest, I still sometimes want to get carried away and spend more than I earn BUT fortunately, we have a financial advisor who we check in with at least quarterly and that holds me more accountable than I do myself. Seeing those monthly statements from 401Ks, IRAs, etc. is great incentive to keep doing the sensible things.
And, JD, it’s likely those comic books still represent something else to you … something missing in your life, escapism, whatever, but hey I get it … we all have those things. I am weak for books and magazines and often I realize they represent who I want to be with a better decorated house, a skinnier body, etc. than who I am and 99% of the time reading them does not change who I am at all. And, major kudos to your on your fitness path. I don’t get to that blog of yours, so I like when you report on your efforts here occasionally–biking 16 miles in one day was awesome!
July 17th, 2008 at 3:23 pm
I totally understand the reasoning for debt snowballing for the psychologic effect, and in most cases I would absolutely agree this would work. However, being a mathy type person, I couldn’t help but do a little research on Chris’ scenario.
Under the conditions he listed:
Acct #1
$1500 balance
10% interest
$15 minimum payment
versus
Acct #2
$2500 balance
24% interest
$25 minimum payment
$100 to throw at the balances
Using an amortization calculator, in this case a debt snowball in its simplest form is a bad idea. Why? Because if you throw all that $100 at the lowest balance so you are paying $115 every month, you will pay it off in approximately 14 months. Great, right? Wrong. At the end of 14 months, Acct #1 remaining balance will be approx $98.80 and Acct #2 will be approx $2867.00! Paying $25 minimum to Acct #2, your debt will actually GROW by $367 because you aren’t paying off any of the principal in the same period of time.
So while Acct #1 is shrinking, Acct #2 is accumulating interest, which would negate the psychologic effect of clearing off a balance, in my opinion.
For this scenario, this is what I would recommend you do for the “snowball” effect.
Scenario 1: Split the $100 extra between the 2 accounts. So pay $65 to debt #1 and $75 to debt #2. Debt #1 will be paid off in approx 26 months, which will be before debt #2. You will pay off interest AND principal to both accounts.
Scenario 2: Split the $100 extra between the 2 accounts, but pay $90 to Acct 1, and $50 to Acct 2. You pay off Acct 1 in 19 months, and pay the interest only to Acct 2.
How did I figure this out? Learn and love amortization spreadsheets.
Basically, my bottom line advice: Stay in school, kids, and don’t neglect your math skills. And don’t get into debt. And eat your peas while you’re at it.
July 17th, 2008 at 4:14 pm
This is my favorite article you have written. I will print it out and send it to my girlfriend.
July 17th, 2008 at 4:16 pm
J.D.,
I love your blog and have been reading it religiously for some time now, but this is a point where I’m going to continue to disagree with you. The first point I would make is that it was not the snowball which paid off your debt; you did. You acquired and exercised the needed discipline, not the snowball. The snowball worked for you, yes, but it worked for you because you let it — just as paying off your debts in the optimal manner would have worked for you if you’d let that.
Now I will grant that it would be foolish to dismiss human factors — which is why I suggested charting the progress (and the progress vs. the alternative) in lieu of engaging in deliberately wasteful behavior.
If I argued against putting my money in a high-interest savings account because I found psychological value in having a big balance in my checking account your response would not be “Oh. Just keep your money in your zero-interest checking account insead, sure it will cost you hundreds of dollars but that doesn’t matter…” You’d suggest a spreadsheet that showed the totals of the accounts to satisfy that psychological need or or or…
Finally, I know how big the difference is (or was for me) because I did the math when I was paying off my debt. 5% may have been the number Trent arrived at for the problem he solved but that should in no way be held up as “just a 5% premium”. Consider the different interest rates different people have on different amounts of debt and their differing ability to repay them quickly and that 5% figure rapidly becomes meaningless.
PS: @Cathy - Congrats on being debt free, and yes, the numbers you so effectively attacked were clearly pulled from thin air. Had I expected someone to actually run the numbers I would have come up with a better toy problem. Or pulled out the real numbers from the depths of my filing cabinet. YERGH!
July 17th, 2008 at 4:40 pm
Right and Optimal aren’t the same thing. While I lean towards the mathy side (highest interest first), as long as both methods end up paying off the debt, a good thing has happened.
I listened to the Dave Ramsey show four or five times. Some of his callers stories fit the stereotype of trailer park high-school dropouts working at a low wage manual labor job. Lots of these people either haven’t had or taken a opportunities to learn how to manage their money.
In my mind, any method that will get them out of debt is a good thing. Any type of financial structure is more than they’ve got. If they have a hard understanding percentages and interest, or they just don’t have the patience to pay it of the best way (due to lack of perceived victories), then the snowball method might just be what they need.
If there were a right way to invest there wouldn’t be thousands and thousands of books on the subject telling people how to do it.
July 17th, 2008 at 4:45 pm
Chris:
Actually, my point might have been a little obtuse. I was actually trying to point out that people should make sure to do their research when tackling their finances, especially debt. I think debt snowballing can be great, but taken at its face value, it could work against you, as the example of just blindling throwing all extra money at the lowest account. When I was looking at my debt strategy, I ran all kinds of numbers to make sure I knew what I was getting into.
What worked for me was consolidating all my bills onto the lowest balance transfer offer I had available, and paying the transfer fee. After many calculations, I determined I would pay significantly less than the regular rate finance charges on each of my balances. This only worked because:
1) I had enough credit available to consolidate the balances onto one card so I only had one bill to pay and keep an eye on.
2) The balance transfers had a cap on the maximum fee they would charge.
Not everyone may be able to do this. But regardless of what method you use, I think you should run numbers and do your research so you know what you’re getting into.
However, there are some things that don’t fit neatly into the math. Like JD, I didn’t truly get a handle onto my finances until I had a small emergency cushion in cash. That seems totally counterintuitive - why not throw everything and ebay the kitchen sink to get rid of the debt? Because I needed the kitchen sink, and I needed cash to pay for things - not credit. Of everything I did to get rid of debt, honestly this was the scariest and I did a lot of second guessing. But the first time I had an emergency (car battery needed to be replaced) and I paid in cash - it was my first taste of freedom.
July 17th, 2008 at 5:51 pm
Cathy: It doesn’t change the fact that I presented you with a busted toy problem; consumer lines of credit like Dell offers don’t generally allow for payments so small that they don’t service the principal. Egg on my face.
July 17th, 2008 at 5:51 pm
While I lean towards the mathy side (highest interest first), as long as both methods end up paying off the debt, a good thing has happened.
I would say the right way is the optimal way, assuming you can properly address all costs and risks. Course, we can’t, which is why we have this debate.
However, this logic doesn’t sit well when the general advice from the same people are about slicing every single cost, as much as possible. Chris mentions high interest savings accounts, and I agree. The same can be said here - so long as people save, what does it matter?
A good thing is good. And paying off in order of interest rates is even better. A matter of scale? I don’t expect that from a community where fractions of a percent are a big deal.
I’ll grant that maybe people who were out of control will gain from suddenly feeling in control, but I also believe that using that trick doesn’t make them any more stable in the future. Any loss of control can spiral downward. Grim determination, optimizing your finances and so forth is a stable, if harder path. And in tangible terms, achieving that determination will keep you going. Commitment via wins will go away when the wins go away.
If there were a right way to invest there wouldn’t be thousands and thousands of books on the subject telling people how to do it.
Then the authors that advise you to just buy random mutual funds, regardless of management fees are as “right” as those that advice devling into those details?
The same analogy with money-clueless people could apply there, I believe.
(I hope the quoties work! Nope, italics it is!)
July 17th, 2008 at 7:38 pm
Something that has been left out of the equations above is that it’s not just the amount of debt you have that decreases your personal security - and therefore quality of life - it’s also the number of accounts you have.
So, I elected to pay off lowest balances first for a specific reason: it improved my quality of life to reduce the number of companies who “owned” a part of me.
To be fair, my interest rates didn’t have nearly as wide a spread as the examples above.
Now, I predate this Dave Ramsey fellow you all are talking about, and I don’t know a thing about him. So this isn’t an endorsement of his method.
I’m just suggesting that elimination of debt is a way to improve quality of life. After all, if it didn’t hurt us in some way to have that debt, why wouldn’t we still be living beyond our means?
July 17th, 2008 at 7:47 pm
Wow, GREAT article, JD! It’s going to become an authority document in no time, you’re going to get a 1,000 links from this post. Very honest and compelling, it’s amazing that you can write so many posts per month but still keep the quality level so high.
I agree with you on Ramsey’s snowball approach, it’s my favorite and the one I recommend the most to beginning wealth-builders that are struggling with debt. I’ve seen people that have struggled with their debt for years turn their lives around pretty quickly with this method. Who cares about paying on the card that is charging you the most interest if you’re not making any progress on your mountain of debt, right?
The Debt Snowball provides rewards along the way, and these rewards encourage you to continue paying down your bills. The other major benefit of this approach is that it instills good money management and saving habits without you even realizing it. By the time your debt is gone, you’ll be a disciplined wealth-building machine.
It’s not the only approach, and certainly not the best for everyone, but it works well for many people. Especially people that need small rewards along the way to instill good spending and saving habits.
Cheers and congrats on this post, JD, it’s going to help a lot of people and get a LOT of well-deserved links.
Odd Lot
July 17th, 2008 at 7:59 pm
JD: Great post. I read you every day and this article really put it all together in no uncertain terms. Thank you for writing it!
July 17th, 2008 at 10:11 pm
Others have debated the debt snowball and paying off the smaller debts first versus the optimal payment. What folks often forget, and what mimms mentioned above, is that most people in serious debt don’t have two or three debts as Chris’s example gave, they can often have six to ten (e.g. two Visas, a Mastercard, a Discovery card, two department store cards, a car loan, student loans, personal loan, or any combination or multiples of the above). These folks aren’t just getting hammered because of the debt, they’re getting hammered because of the late fees and feelings of being buried and harrassed because just as a check for one debt leaves they get two more bills in the mail. They can’t help but feel they’re bailing out the Titanic. So if they can knock out a third of those debts in a year, the pressure begins to ease and they can feel the progress and start really looking beyond the debt to other options. Even one less nagging bill under these conditions can make a difference.
@ Finn Grim determination typically comes along when you’ve hit rock bottom. But even then, you have to make a workable plan, execute it, and see real progress. If you aren’t going to see a debt significantly reduced for a year, it’s going to be really hard to maintain that determination, especially if you’ve got a spouse and kids and society pressuring you otherwise. Gaining those victories, at minimal real costs (say 5% of total debt over a two to three year payoff period) can make a positive change in many people, it can grudgingly win over a spouse skeptical of the method, it can be used to show the kids “one down, five to go”. There will always be those who stop moving once the dangling carrot is removed, never recognizing it was only there to get them going in the first place. However, many others like the momentum they build up, and do make permanent changes.
July 18th, 2008 at 12:54 am
I would really like to see a post on the pros and cons of web-based financial tools and then a comparison of the four you mentioned in this post. I can’t wait to read user experiences too. From my quick glance, I am not sure they would work to my satisfaction.
Thanks!
July 18th, 2008 at 4:54 am
Kudos on another great post, JD! This one I’m sending to both my daughters and my mom.
As has already been said, once you hit rock bottom or get “tired of being tired of it”, you finally figure out how to make a plan. It doesn’t matter how you do it, what method you use, you just have to do it. It is all a mental process, anyway. Just do it.
For me, the “mathi-ness” above made my eyes glaze over. If that was all I was ever presented with I’d probably still be in debt
so I’m thankful for something like a “debt snowball”. We’re no longer in debt because of it, well on our way to a six month emergency fund, and for the first time in my ENTIRE LIFE, I look forward to paying the bills come to the house. I love knowing exactly how much money I have, (thanks to rudimentary excel skills) where it is being spent and thinking every month about how to save even more money.
We could argue all day long (hmmm, like those folks in DC) about the best way to do something…and end up doing nothing. If you’re a lurker and still confused, just go back and re-read JD’s post. Then, just do it!
July 18th, 2008 at 5:56 am
As someone who paid off $55,500 in debt (over the course of 12 and a half mos.) using the snow-ball method, I loved this post. We had 8 debts with interest rates that ranged from 0% to 21% (the smallest debt happen to carry the 21% rate). We paid off 7 of our debts in 6 mos. and then worked, slow and steady, on the big debt - my husband’s MBA loan. My husband was in favor of paying off the debt by interest rate but since I was doing the heavy lifting I won out in the end. But you should do what works for you.
I would also add, stop keeping up with the Joneses to this post. 90% of the Joneses you are trying to keep up with are broke or in debt.
July 18th, 2008 at 6:04 am
I love your blog! It amazes me how DH and I were just living our lives, charging up a storm and had no plan for our money, (I’m sure like a lot of other people). We did the Dave Ramsey Financial Peace Class and our lives have been changed! We have been doing the debt snowball plan for a little over a year with probably 2 more to go. I love reading your blog because it encourages me and helps me to stay focused. Keep it up!
July 18th, 2008 at 6:47 am
I paid off my debt in the order of highest interest rate, and it worked. BUT…it was a long, slow haul with very little motivation than seeing my balances start to decrease. Many people do not have the discipline to stick out that long, slow process. If the debt snowball method gives them the motivation (probably a dopamine rush) to keep going and find more ways to save, then it’s a great method!
It works, and that’s all that matters. As JD and others have pointed out…a 5% premium or whatever amount it may be DOES NOT MATTER when compared to never paying off the debt at all.
July 18th, 2008 at 7:51 am
Poor family upbringing has noting to do with not having proper money skill.
July 18th, 2008 at 8:22 am
I don’t understand Chris’ hatred of the snowball method. Being an engineer makes me like optimum designs and solutions. However, being married to a counselor makes me take the “human factor” into account.
Even with only slightly modifying the numbers Chris gave for the example (using $55 for the $2500 balance so you pay the interest plus a little when you get started), the advantage to doing it the “optimum” way mathematically is less than $300 over 24 months. With the snowball method, the smaller debt is paid off in 14 months, 6 months sooner than the large debt would be paid off in the “optimum” scenario. This sooner gratification is more likely to keep people going after their debt instead of just giving up.
In 6 months, the snowball method has one debt below $900 and falling fast whereas the “optimum” method leaves you with ~$1485 and ~$1835 still left in balances. I can see where some people would get frustrated with the optimum method and feel like they’re not getting any traction. If people in debt were good with delayed gratification, they wouldn’t have been in debt to begin with (in most circumstances).
July 18th, 2008 at 8:40 am
I’d have to also agree with people who say your family history does not necessarily dictate how you’ll handle money. It does have an influence, but I’m a great example of how it sometimes has no correlation at all.
Neither of my parents know how to handle money well at all, and they never talked to me about money either. I had no other family members who taught me either. But I had a budget at age 15 when I had my first real job. I don’t recall reading about budgets anywhere. It just occurred to me that I have so much money coming in and I needed to figure out where it would be spent so I wouldn’t run out. I’m not bragging on myself, because I didn’t necessarily use the money well. But I did understand the concept of a budget without actually being taught by anyone.
I’m not sure what it means, but I think it’s interesting that some people are just built to handle money better.
July 18th, 2008 at 8:46 am
Sorry, JD, I think the comments are more interesting than your post.
The funny thing about human psychology is that we all have different ways of getting our rocks off. For some, seeing the # of credit lines diminish is more important than seeing the total amount diminish. And for others tracking the total amount (thus going higher interest first) is key.
For me, not paying any more interest was the most important thing. So I took a small hit to my credit rating and opened a couple of new accounts for the 0% balance transfer. I also took advantage of a no-fee transfer on an empty card. Then I could tackle it as a whole. I also had a set deadline (ie, when the rates would expire) for each card, which helped figure out how much I could pay. But I’m also a statistician….
July 18th, 2008 at 10:04 am
LOL! Like anything else, do what works for you.
– If you are dealing with a lot of negative emotions around your finances and debts and don’t do a lot of math around your finances (where a lot of people are when they start — no judgment here!), the snowball is great, because it gives a lot of positive emotional payoffs. If there are a lot of small accounts, those positive payoffs come regularly. Kinda like getting gold stars for good behavior on a regular basis.
– If you have a solid and relatively objective view of your finances, have only a few accounts, and enjoy dealing with financial math, then doing payoffs “the smart way” to minimize interest payments can work well. Every month, you can calculate the interest saved and give yourself kudos that way for being so smart.
Depends what you need, eh?
As a side comment regarding “gazingus pins” in YMOYL parlance (compulsive spending blind spots, like JD’s comics): I just went to the library and came out with an armload of books and a CD for free, most of which I won’t get around to reading, or will lose interest in. I used to BUY those items — DH and I couldn’t leave any bookstore or Costco for less than $50/trip for movies, music, and books. That was nearly 15 years ago, so double that $$ if we were to do that now. But books are good to spend money on, right? Well, after several moves, dumping books, DVDs and CDs at libraries as we went, we figured out that we don’t need to OWN all those books. (Duh.) We keep being tempted, though . . .
July 18th, 2008 at 10:33 am
I want to follow up about being poor and having no money skills. I grew up with a German mother & Dutch father, both of whom went through the Depression. My father became a farmer after WWII. We had NOTHING….except fresh veggies from the garden, fresh milk from the cows my father milked, fresh meat and eggs from the pigs, cattle and chickens we raised. But more importantly we were taught to be thrifty using things over and over and saving things and money…values lost on most of us today.
July 18th, 2008 at 10:41 am
Your post struck a chord with me, espicially the part about not getting help and relating it to alcoholism.
Very true.
In both cases, the first step is denial, I told myself that I didn’t have a problem. BOY WAS I WRONG !
July 18th, 2008 at 11:15 am
I already shared above that I’ve decided to buckle down and pay off my school loans. Does anyone know if I can do a balance transfer to a 0% card for that? I’ve never investigated the balance transfer industry.
I used to have a thing for cookbooks. I realized I was trying to buy myself a lifestyle full of classy dinner parties, that I would host with expert ease in my lovely apartment. Somehow that never materialized! But instead I got a job in a library and got to buy awesome cookbooks with OTHER people’s money
July 18th, 2008 at 12:35 pm
So here is my issue… I spend way too much $$$. It drives me nuts, I see a gadget I just must have and I buy it, without thinking about anything else… I love this blog, and would definitely appreciate some advice.
I don’t have any debt… I use my AMEX for everything and pay off 100% when the bill arrives. However my stupid spending skills have stopped me from getting what I really want.. A home purchase. I keep trying to put money aside but I am addicted to shopping.. I buy stupid stuff that I have every intention of using, but then just don’t.. Not sure if this is the right forum for my issue but any advice would be welcomed.
July 18th, 2008 at 2:55 pm
Bruce:
I would suggest looking into auto-transfers. Either AMEX or your bank should be able to automatically transfer a set amount per month to a “house downpayment” account. Since you are using the AMEX card so much, I would go with that one.
July 18th, 2008 at 3:05 pm
@Bruce,
Well you just took the “first step”…you admitted you have a problem.
How many times have you put yourself on a budget and paid yourself first? Had a plan?
How many times have you sat down and done a spreadsheet to peer into the future to see what you would have if you didn’t spend X on this and Y on that and instead put all of that money into a high yield savings account (like INGdirect at 3% or another one to your liking) instead.
I’m 55 and have only just done the above in the past 12 months. If you are younger than I, then please think about that plan THIS WEEKEND.
When I sat down and did this back in the spring (really made the “This is how much money I want in the bank” plan by the end of 2008, end of 2009, etc., I REALLY got focused. It is driving my husband CRAZY!!!
Do you have an emergency fund? If not, have a garage sale (or put it on Craig’s list) next weekend or sometime soon.
Best of luck to you.
July 18th, 2008 at 7:50 pm
Articles like this are why I read your site everyday. I’m nowhere near the place to think about investing etc. I’m in debt, have a spending problem that I’ve been struggling with for years and your site gives me hope that I have not completly failed as a human being. Thank You.
July 19th, 2008 at 3:23 am
@Bruce
Check out http://www.thesimpledollar.com today. (I hope JD doesn’t mind me throwing that out..I know they refer to each other’s blogs all the time.)
July 19th, 2008 at 7:32 am
The dirty secret is that people don’t get in over their heads because they borrow money, they get in over their heads by how they spend money. Debt is just another cost. You shouldn’t buy more of it than you can afford.
Most people understand this when they borrow to buy a house or car. They ask themselves whether they can afford the payments. They decide whether those payments fit into their budget (whether that’s a seat-of-the-pants budget or a carefully crafted financial plan).
The problem with credit card debt is that people use it without any real idea of what it will cost. They rely on their credit limit to determine whether they can afford it, without evaluating whether they can actually make the payments on that much debt. In many cases, they can’t.
The real crisis comes when people start using credit to make payments on the credit they can’t afford. That is essentially what happened with the folks that kept refinancing their houses, taking out equity to make the payments. That is what happens with credit card debt when people start buying everyday necessities on credit because they already have more debt than they can afford.
The starting point for managing debt is to decide how much credit you can afford. Once you know what that number is you will be a lot more likely to spend it wisely. If you decide that number is zero, fine. But for most people, wise use of credit will allow them to live richer, fuller lives.
July 19th, 2008 at 6:28 pm
JD, wonderful post!!!!! I am struggling with solvency while I stillllllllll don’t have a job; heavy looking, much actions in all kinds of directions.
I am using cash. Paid off the IRS. Thanks
G-d. Clean/sober many years.
Keep doing the next right action and posting on your magnificent board. ODAT.
July 21st, 2008 at 7:45 pm
“Because I’d grown up in a poor family, I had no notion of proper money skills. ”
This sounds a bit odd to me also. I grew up in a financially tight family, and it *taught* me the value of money. Now I have an OK job, but I still demand value and look for deals (and read this website!)
Aside from that, this is a GREAT article. I don’t have debt yet (hello Mr. Mortgage!) but I’ve forwarded this on to a few friends who are in a similar situation.
August 4th, 2008 at 10:53 pm
I wish I was reading blogs like this a few years ago. I wouldnt be in the shit I am now, owing more than $1,200,000 to friends, family and banks. I would know all the right steps, I would get motivated and inspired… Now all I have left is a site called http://www.savemefromshit.com, which is more an example of what to avoid in life, rather than a cry for help…