This post is from April Dykman, a new GRS Staff Writer. April was a typical GRS reader who used the things we talk about to improve her financial situation. Now that she’ll be writing for the site, she wanted to start by sharing some background on her financial history.
In April 2008, I got married. My in-laws graciously gifted my husband, Luis, and me with an adventurous honeymoon in Mexico, complete with scuba diving, climbing Mayan pyramids, and navigating local markets.
Once we unpacked and settled into married life, we knew it was time to get our finances in order.
We had some consumer debt, and then a few months before our wedding my husband’s company was bought out. He was unemployed for two months. We didn’t have an emergency fund, so money saved for the wedding (paid for mostly by my parents, but we wanted to cover some expenses) paid bills instead, and with balances from wedding vendors due, we relied on credit cards.
We were anxious to be debt-free, and we accomplished that, and more, within one year. This is our story of how we used some basic principles to accomplish our goals.
Getting real
The first step on the road to recovery was to gather balance statements for every credit account to our names. That number included:
- Credit cards ($11,200)
- Auto loan for my vehicle ($10,000)
- Motorcycle loan ($6,000)
Grand total: $27,200. Gulp.
I think for many people, this simple first step is scary. Maybe, like me, you piddle around, paying a little extra, cutting back here and there, and you avoid The Scary Number. Maybe you’re terrified because you think you’ll never manage to pay it off. Maybe you’re worried that you’ll have to change your lifestyle, and your friends will think you’re a loser and you’ll turn into a crazy cat lady and when you die no one will find your body for weeks. Whatever the fear, I suspect most people need the wake-up call. I know I did.
Getting a plan
I don’t think it matters whether you pay off the lowest balance first for a psychological boost or pay off debt with the highest interest rate to satiate your logical side. What matters is having a plan. We decided to apply money toward the credit cards first, lowest to highest balance, then the vehicle loans.
I also started to track our spending in a spiral notebook.
Identify big gains
Next, we looked for ways to put big dents in our debt. The motorcycle loan was obvious. My husband rarely rode it because it made me a basket case, and it wasn’t a viable work vehicle. He placed an ad on Craigslist and sold the bike, eliminating a $200 payment.
Then, in May, his truck was totaled. Thankfully, he was okay. We received an $8,000 settlement and contemplated not replacing the vehicle. More than a few people thought having only one car was asking for marital strife, but GRS readers encouraged us to give it a go. We put $4,000 toward the credit cards and saved $4,000 just in case the one-car scenario didn’t work out. Today we still have one car and buying another is a low priority. It was one of the best decisions we’ve ever made.
By July 2008, we were down to $11,600 of debt and had $4,000 in savings.
Identify small gains
After a few months of tracking our pennies, I was able to get an idea of where our money went, and we made smaller changes such as:
- Cutting back on eating out at lunch.
- Downsizing my cell phone plan (I hardly use it).
- Reducing the grocery bill—expensive specialty foods could be cut for now.
In August 2008 we made the final credit card payment.
Using windfalls wisely
In September, I received a $500 bonus and $300 from freelance work. The $800 went toward the car loan. I remember thinking that soon windfalls would go toward saving for the future, not paying for the past.
Establish an emergency fund
Our $4,000 savings was a pseudo emergency fund, but it was really money earmarked for a second vehicle should our one-car plan prove to be a disaster. But life without a second car was going well, and we were anxious to wipe out the last of the debt. We used some of the money in savings to pay off the auto loan, leaving $1,200 to establish an emergency fund. We were officially debt-free.
We immediately reallocated debt-repayment money to our emergency fund. By March 2009, we had saved three months of expenses. We were then free to save for more exciting dreams, such as building our house, travel, and retirement. We opened a targeted account for each goal, and every month we see our savings grow as we pore over floor plans or dream up our next adventure.
Lessons learned
I’m proud of how far we’ve come, but looking back, there are two things I’d have done differently.
- Live (a little). I tend to go at something full-force. After a couple of months of miserly behavior (mostly on my part), we eased up and allotted money for frivolities, creating a bit of life balance in the budget.
- Start with the emergency fund. First, it mitigates future risk. Maybe a tire will blow out. Maybe the A/C will break down when it’s 100 degrees outside. We were simply lucky that neither happened. Second, there’s a psychological component. Dan and Chip Heath, authors of Made to Stick: Why Some Ideas Survive and Others Die, make a case for the whisker goal, “a target that [is] a hairsbreadth away from the status quo.” While “stretch” goals (pay off $27,000 of debt) are great if you feel empowered, whisker goals (save $1000) are better if you feel overwhelmed. They can get you past the fear that holds you back.
It wasn’t easy. While we had the benefit of a middle-class income and the luck to have no major setbacks, we also made big lifestyle changes. We were highly motivated from the day we calculated our total debt.
I think taking that first step was key for us, but what about you? If you’ve paid off debt or are currently doing so, what do you think are the most important actions you’ve taken to become debt-free?
J.D.’s note: EVERYONE wants to skip the emergency fund. I did too. We listen to people on the other side say “start with the emergency fund” and we think “meh — why do I need to?” Well, now that I’m on the other side, I wish I’d started with the emergency fund too!
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Brent:
Joe already said what I was going to say. Am in same situation as you except 28 with $180K of debt from med school.
I max out the Roth every year because it would be stupid not to when my salary is going to increase and I won’t be able to contribute to a Roth anymore in the future. Since I invested in emerging markets this year, so far I’ve made about 25% on my investment – a lot more than I’d gain by paying on my loans! But honestly it’s not just a rate numbers game. Even though my subsidized loans are even less than Joe’s at 1.88% for one piece of them right now, I still want to get everything paid off even though rate of inflation is going to make that ‘illogical’…. I just don’t want to think about this debt anymore, I refuse to be still paying it off 30 years from now. But it’s up to you depending on your loan interest rates and perspective on this.
I throw all my extra money at the piece of my loans (currently $29K) that is unsubsidized 6.8% interest rate, and I have been doing it for two years now and have really seen the difference in the amount of interest I accumulate per month. At the beginning it was about $12.50 in interest every DAY just on that piece of the loan. Now it’s a lot less than that! So when my loans come out of deferment next year it will be a significantly smaller monthly payment. So I say just put anything you can towards paying it (while still maxing your Roth on an automatic investment plan or something), and be happy with ‘whisker goals’ – like for me, I just celebrated getting the high interest piece of debt down under $80K. yay!
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I never had a debt problem BUT I never built much of a financial cushion either until I was in my late 30′s. I worked at low wage jobs, had a few hundred or a thousand dollars as back-up, a single credit card that I paid off most months, and just didn’t spend more than I had. In my mid-thirties I realized that I had goals (sending a child to college, retiring some day) and started educating myself about money, saving, and looking for better paying jobs.
I’m curious. Given a job loss, I would have scaled back the wedding rather than go into debt. Did you consider that? I don’t mean this as a criticism. You are way ahead of where I was at your age but I’m interested in the psychology of the choice.
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@Kevin–The thing of it is that it didn’t cause any strife at all! Since getting married, I’ve found that most people give bad marriage advice. Supposedly, we would fight our entire first year of marriage. We’d argue over having one car. We should be prepared to argue while building a house. But none of that has been the case. We’re on the same team. I think sometimes it’s good to ignore advice.
@Chris–Very good point. The problem was that we were two months away from the wedding and deposits were paid and contracts signed. Guests were already invited, and the head count accounts for a large amount of the expenses. I’m not saying it would have been impossible, but at that point, we were just overwhelmed. It was sort of like “let’s just get through all of this and buckle down afterward.”
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Brent,
As the others pointed out there are a lot of unknowns with your situation. I will add that if you have several loans at various interest rates, it may make sense to pay off one or several loans if you are worried about cash flow each month (particularly if you have a few loans with a high interest rate). If your loans are with SallieMae, sign up for automatic debit for the 0.25% rate reduction, and after 3 years of on-time payments they’ll take off another 1%. Unfortunately this does not reduce your monthly payments.
For the most part it’s a numbers game, but paying down the loans is a guaranteed return while stocks and bonds can lose value. I’m betting that over the long haul my investments will return 6%+ after taxes so for me it’s worth the risk to invest in a taxable account. If my loans were 4 or 5%+ after the tax deduction I would consider paying them off before investing in a taxable account.
I still put a little extra money towards the higher interest loans when I get unexpected cash, but unless I get a huge windfall I’ll probably continue make the minimum payments on the loans that are less than 2%.
-Joe
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Thanks April! It’s great to see you writing here, and I loved your story. We’re about half-way through the credit-card payoff in our own debt-slog, and this was the first month since we started in January that I’ve put money aside for frivolities. It felt good, but I think it may be awhile before either of us is brave enough to spend any of that cash.
I’ve gone slowly with the emergency fund, and reading this essay inspired me to step it up.
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Weddings are a big killer. I had a friend who called off his $80,000 wedding two weeks beforehand, and it therefore cost the couple $40,000.
The best wedding I ever attended was a 16 person wedding on a public beach in Hawaii. Lasted 45 minutes with pictures, and cost about $750 bucks including the lunch reception.
April, looking forward to hearing more of your stories.
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fantastic story and great article. Stopping by from Northern Cheapskate
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April D: “By July 2008, we were down to $11,600 of debt and had $4,000 in savings. . .”
“In August 2008 we made the final credit card payment.”
———
Do I undertand this correctly: You paid off $11,600 of debt in one month, between July 2008 and August 2008?
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We’ve been doing the one car thing too but we’re actually considering buying a used van from my hubby’s work to make life easier over the next year or two (we share a house with one of our grown kids and her family and juggle 4 adults going to work, getting 3 kids to 2 different schools, etc. with only one car for each family).
As for Financial Samurai, I’ve never done anything like his 1/10th rule for buying a car! In fact, I’ve never heard of it. Do you suppose many execs earning $160,000 would actually buy a $16,000 car?
When I was a single parent with 3 school age kids I was making $26,000/year and bought a car that cost that much! It wasn’t a problem to pay it off. By his rule, I’d have had to drive 3 kids around in a $2,600 beater. Like I’d been doing before I bought a really nice car (one which later saved my life and that of my kids and mother when we were in a major car accident where we’d likely have died in a smaller car).
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Thanks for this nice article. I had to laugh about the “live (a little)” thing! Its hard to spend money for fun when you just started to think about every cent.
Looking forward to read more articles!
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“Do you suppose many execs earning $160,000 would actually buy a $16,000 car?”
That’s about what I make, and yes, if I was going to treat myself, I would buy a new Honda Fit for about that much. But I’ll probably just pick up a used one, and not for awhile yet, since my current car is running great.
When you’re only making $26k it’s a tough “rule” to follow, but the idea is laudable, I think.
Back when I was in the Navy, the parking lots were arranged with many reserved spaces according to a range of ranks (i.e. E-6 and below, E-7 and above, O-5 and above, Flag Officer, etc.) In the military it was no secret how much a person’s income was, and yet there was a definite inverse relationship between the “rank” of the parking area and the value of the cars occupying it. Lexuses (Lexi?), BMW’s, Jaguars, and fancy SUV’s filled the spaces of the most junior personnel. The junior and mid-level officers favored Accords and Saturns, and the admiral drove the family’s 15 year old rusty van.
There are many military people who read this blog, and I am sure that many could confirm this story–as a general trend, not a rule without exception.
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@58 Jean:
No, the $11K total debt at that point includes more than just the credit card debt, it includes some car and/or motorcycle debt that they had.
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Hi Shevy,
Yes, absolutely. If you are making $160,000, you should limit your car purchase price to $16,000. You don’t have to buy a new car. You can buy a perfectly safe, 5 year old car for that price with 50-60,000 miles.
I STRONGLY believe that cars are the #1 personal finance killer for those under 30 years old. For some odd reason, people actually borrow expensive money to buy a depreciating asset when they don’t have money. How does that make sense?
The rich use this rule all the time. If you are an executive in management consulting like McKinsey, BCG, or Bain, you are probably making $2-5 million a year. The cars I see them drive around Honda Accords, BMW 5 series, 7 series, and SUVs. The price range is $25-90,000… or actually only 1/20th to 1/100th of their income. Not many are buying $200,000-$500,000 cars.
I cannot emphasize enough how important it is to try and stick to this rule. Oh yeah, and you probably haven’t heard of the rule b/c it’s a Financial Samurai rule, and we haven’t been around very long. But hopefully, the rule will spread all over in time
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Re: Ann (13) I cringed when I read that you risked your own security to help out your “parental units” -glad you have an emergency fund again! As the mother of five (four are adults), I often find myself struggling with feeling selfish whenever I have “extra” money. Not that my kids expect handouts -they don’t, but I still feel guilty!
I do have a question for everyone – I am a Master’s level mental health professional feeling stuck with the pack when it comes to earning power. I can’t seem to think outside the box as to changing things. Any ideas?
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I wholeheartedly agree with starting with an emergency fund. It’s a lot easier to look forward and save when you aren’t constantly putting out fires and digging yourself out of holes created simply because you didn’t have a safety net when old Murphy came around. And he always does…when you least expect him.
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I went about things backwards I guess. I had already faced The Big Number and started keeping a notebook to keep track of bills and expenses before I heard about Dave Ramsey. I mostly thought I would be putting the cart before the horse if I read too much financial advice before I got a handle on the easiest way to do it for myself. Sure enough, just keeping expenses in Wordpad works the best.
I paid things off before I started the emergency fund since I balanced the 5%< interest I would be paid against the 18 – 23% I was paying. Once I had a system and I put it on automatic, things fell into place and the debt kept shrinking. I still had to deal with emergencies with my same old feelings of doom and despair as I used the plastic. But one the debt was paid I knew this time would be different. I didn’t daydream about the things I would buy on the day I had the credit cards paid off. I was determined to change and to save up for things and not charge them. I’ve fallen down a little but I get back on track faster now.
I have to say even a small emergency fund makes me feel calmer about the future. My fund may be different because I am certain the income will keep coming in but I have to be ready for something like replacing a water pump or hot water heater. Those kinds of things always seem to happen to me.
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@Idea – I’ve been there with an ex and unfortunately that’s where about half of my $50k debt came from. In your situation I suggest giving her spending money, weekly, and when it’s gone, it’s gone. If she won’t go for that, then you might have to disentangle your accounts and pay for things separately. It sounds harsh but she is risking your financial future as well as her own. Your wife might not like to have the talk–it can be really scary for someone not good with money — but it needs to be done. My ex saw me as his cash cow. If your wife doesn’t want to think about money then she’s pretty much treating you the same. Please for your own sake don’t let it continue.
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Thank you @April and @Not My Mother for your comments. You enforced the idea that I thought of myself.
Yesterday I proposed my wife to create a budget for her spending and surprisingly she agreed. I even created a contract that regulates all issues about her future spending and she signed it
Thanks again
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I’ve never carried debt except for my mortgage … but the mortgage feels like an insurmountable burden because it’s almost three times my annual GROSS salary. Screw the tax deduction … I feel like I am throwing money away every month because I rushed into financing the property instead of saving up for it. Lesson learned! Gotta play by the numbers, not emotions. But what can I do about it now that I realize how much it is actually costing me? Additional principal is automatically included with every monthly payment. This detracts from my other savings goals but psychologically it is starting to make me feel better to see a more significant drop in the mortgage balance after each payment is applied. I still have that feeling like it will never get there though. Even if I paid an extra thousand per month, it would still take me over five years to completely wipe out this debt. Ouch.
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Nice post. Good tips.
As you pointed out the first step is the hardest– knowing where you stand.
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Some of the most important steps I have taken:
1) Looked at my income and expenses and figured out what kind of life I could really afford to live at the time.
2) If I wanted to add more expenses (maybe a few more nights out a month, maybe eating out 5-6 more times a month, etc.) figuring out how I can add to my current income.
3) Looking long-term. I’m planning on getting married in the near future, and I don’t expect to get a lot of help from either parents – figuring out what I need to save, planning, etc.
4) Keeping an eye on unnecessary spending. You said keep an eye on the small stuff like eating out for lunch. This summer I have packed a lunch nearly every day of work and I can guarantee it has saved at least a few hundred dollars (if not more).
Looking forward to your future posts!
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Thanks for such an inspiring story April. Just goes to show that with determination you can get out of any debt. What is it that Marty McFly says? ‘If you put your mind to it, you can accomplish anything’
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Used my emergency fund big time in past year. Aug 08: $5k for A/C failure during heat wave. March 09: paid ~1/2 of $19k air ambulance to move my mom from rinky dink hospital near her vacation site to good one near me. The last, esp, convinced me I want to keep a sizable emergency fund that’s very liquid.
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Annonymous (61)–”When you’re only making $26k it’s a tough “rule” to follow, but the idea is laudable, I think.”–I actually more agree with the 10% rule for lower incomes. (BTW, I’ve never heard of the 10% rule before this thread!)
In my previous career I’d see people with $30k incomes and $30k car loans at $600/month. A person at that income level is heading for disaster with that situation.
He/she would be better with the 10% rule, buying a used beater for $3000, and saving up enough money to buy something better in the future. Just because a lender says yes to an outsized loan doesn’t mean you can afford it.
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Every time I read a post like this I really question whether this is realistic. My wife and I have $44k of debt (not including mortgage), all on a secured line of credit at 2.25% interest, but that’s everything (cars, student loans, etc). This seems completely normal and even below average for someone my age (30).
I think (and this is completely my opinion) that it is insane to toss extra money at debt that’s at a low interest rate right now, when I can be investing in a market that is extremely cheap at the moment.
And about having an emergency fund…yeah I would if I had my debt paid off, but I have space on my line of credit for any emergency, and the money is dirt cheap. Why would I leave thousands of dollars in an account that wasn’t earning much interest?
I dunno, maybe I look too much at the math, but a lot of the decisions people make don’t seem to be based on logic.
So that said, when I was 25 and making $60k I bought a $40k BMW @ 1.9% interest, because i wanted it. Do i regret that decision? Hell no, it makes me happy every single time I get in it. I LOVE driving that car.
I fight with myself every day because I have two mentalities, one long term mentality that makes me plan and save a lot, and one short term mentality that says I could die tomorrow so better enjoy now.
Last thing..before you think I just blow my money, I have been saving in RRSP (canadian version of 401k) since I was 18. Together my wife and I have about $100k saved and we are currently at a point of saving over $30k a year. Here I come early retirement…
Oh, and just to ensure I retire when I want, with the money I want, I got off my lazy butt and started a side business to increase my income.
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@Lee:
Congratulations on your RRSP accounts. From what I’ve read, the Canadian financial system and the Canadian health care system are in much better shape than the US versions during this widespread recession. A 2.25% secured line of credit sounds incredibly cheap. I believe that today’s student loans are in the neighborhood of 5.6% or greater, and that would also be true of Home Equity Lines of Credit. Can’t say for Canada, but here in the U.S., the terms of all these loans has changed widely, and not to the benefit of consumers. The companies may adjust everything with very little notice, so that in the best case, you are suddenly paying 22% for money that you need for an emergency, and in the worst case, 22% for a quarter of the credit line you had originally. You may have read that 60% of U.S. bankruptcies are due to medical debt. Because the average U.S. consumer is exposed to these risks a great deal more, the need for cash as a hedge is greater.
As I read your situation, you are unlikely to have crushing medical debt, and your secured line of credit terms are not likely to change as capriciously, so keeping a large cash cushion is not as necessary.
Regarding the BMW — when one can honestly say, it’s worth every penny to me, and one can also honestly say that it doesn’t impact basic expenses, a splurge needs no further justification.
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@L. Hernandez:
Hmm, my LOC just rides on prime, I figured that there would be comparable credit vehicles for the States…but maybe not.
You’ve got the bit about medical bang on. Technically I don’t pay a dime of my own money for medical care, although we do indirectly through taxes. That said, it’s also a long wait for some medical care. A lot of Canadians are building a nest egg of capital just in case they get cancer or something severe. If they do they just fly down to the states and get fixed up without a two year wait. So there are ups and downs to both systems.
Don’t get me wrong, I REALLY want to be out of debt, not just consumer but mortgage as well. I can’t even imagine what I would do with thousands extra every month even after maxing all my saving vehicles. I can’t wait until that day!
@April:
Don’t read my initial comment as disagreeing with your approach or goals. They just seem so different than mine, and maybe part of that is because of differing systems between the States and Canada…
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Thank you for sharing your story with us. I could identify with a lot of your points and goals and methods.
I’m still paying off my debt of around £15,000 ($25k USD) but, I’m getting there. My blog is my diary and also my soap box, much like GRS but aimed at the UK instead.
It gets next to no visitors but I don’t mind. Writing it down and knowing it might help just one person is enough motivation to continue!
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Financial Samurai has it right. 1/10 for car would suffice. Many 20-40 year olds will trade future wealth for car payments. That’s their choice (but, I doubt they really understand the numbers).
You would not guess my income by the car I drive.
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From one April to another, I thank you for this story! You are so right that it is so hard to add up your total debt. We finally did it a few weeks ago and it is staggering! Great story.
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