I started reading this blog a few months ago, and some of the posts gave me the inspiration needed to start getting out of debt.

I'm 24 years old. The big eye-opening step for me was calculating my debt. I just avoided knowing how much it was, didn't read my bills/CC statements etc. I found out I had about $7500 in credit card debt. I'd been living paycheck to paycheck, trapped in a world where I couldn't afford to pay hardly anything over the minimums each month, so my debt was never going down.

I found out I had missed a payment for the first time ever (on any credit card) with USBank Visa, and they raised my APR up to 34%. I had a $2300 balance on that. I knew I had to pay that off ASAP somehow. I got lucky and my car (which is worth maybe $1000) was hit in the parking lot at work. There was a small dent on the fender. I ended up getting $750 from the other drivers' insurance company. This was the first time I could make any signifigant payment towards my debt, and it gave me the momentum needed to get my butt in gear.

I'm not sure if this would be considered a mistake or not, but I took a $2000 loan from my 401k to pay off the rest of my USBank Visa (and a little bit of some other debt). I'm paying 9% interest on that. Better than paying 34% interest to USBank, right? I hope so.

Anyways, I'm now down to about $4300 in credit card debt. I've made the following lifestyle changes just in the last 2 months:

* I'm moving at the end of this month from an apartment that cost $811/month to a place that costs $649/month.
* Cancelled internet service on my cell phone ($30/month)
* Lowered my car insurance from full coverage ($130/month) to liability (now it's only $43/month)
* Worked my arse off at my job to get a promotion, which resulted in a 13% pay raise (just took effect April 1st!) -- which in my case is about a $2.15/hr raise
* Switched my checking account from USBank to ING (electric orange!) where my money will earn 4% APY while it sits waiting to pay bills
* Setup my direct deposit at work so that 6% of my after-tax income gets deposited in my ING savings
* Increased my before-tax contributions to my 401k from 5% to 10% (and my employer matches 5%)

I've now got a lot of my money going into savings. 10% of pretax dollars into my 401k (which is about $140 every 2 weeks), and 6% of my after-tax dollars going into ING savings. Is this the right thing to do? Should I focus less on saving and more on paying off debt? I've been reading Dave Ramsey's stuff and he says to develop a $1000 emergency fund before paying off your debt. I'm not sure how I feel about that. Opinions?

- Jason

With the exception of taking the loan from your 401k, I think everything else you're doing sounds right:
- Working harder, check.
- Lifestyle downshift, check.

If I've read the rest of your question correctly, you've paid off about $900 in 2 months. Keep it up at that rate and you'll have paid everything off around the end of the year (give or take). If you're careful and disciplined (which it sounds to me like you are) you can probably delay your emergency fund until then, considering you're already putting 6% into savings. If you continue through 2008 at the same savings rate, you'll have a really nice emergency fund, maybe even enough to start either a Roth or a vacation fund.

I suggest you find a 0% balance transfer credit card so that you make some more headway. If you can't get approved for one (I can't imagine that though) call your current card company and ask them to lower the rate. Be contrite and businesslike with them, explaining your otherwise good payment history. Let them know you'd like to continue being a good customer as opposed to taking your business elsewhere, etc. It might take you an hour on the phone as you get transferred from rep to rep to manager, but think of that hour as the price for getting a lowered rate.

Here's why I don't like the loan from your 401k: Not only are you paying 9% on the money you borrowed, but that money is no longer growing at ~8%. It's overly simplistic to say that you're paying 17% on that loan, but that should help you visualize what you're losing in terms of growth over time.

Thanks for the reply. I'm not 100% positive on this, but I -think- that the way it works at my company is when you repay the 401k loan, you're paying that 9% interest back to yourself. I just lose a fee for the loan (which is $75). I might be wrong. But either way, isn't that better than paying 34% towards a credit card?

I think the moves you've made to cut your monthly expenses and increase your income are *awesome*. That should serve as an example to anyone in a similar situation. (Obviously cutting our collision on your car only works if you're driving a beater).

I'm not sure I'm reading your numbers correctly; if a $2.15/hr raise is 13%, you should be making about $18/hr, or $3K/month now. Then 10% pretax going to 401k should be $300/month, not the $140/month you mentioned? I'll assume the $140 is actually per paycheck, and then the numbers are pretty close to working out.

I think you're doing all the right stuff. So long as you keep your expenses down while saving and paying debt, you'll get to the same place in approximately the same amount of time no matter how you allocate the savings and debt payment.

Having said that, if I were in your situation I would cut my 401k contribution back to 5% to get the full employer match, and put the extra 5% towards beefing up your emergency account. Ramsey's number of $1K sounds fine. At $300/month, you should get there in a few months. That way if your car needs repairs, or whatever, you won't have to raid your 401k again. The key with your emergency account is to not touch it, unless it's an emergency.

Once there, I'd put that 10% towards debt until that's gone. Then resume your 10% contribution to 401k, but keep feeding 5% into your after tax savings account slowly increase your emergency account.

Regardless of exactly what you do, though, keeping your expenses down is *the key* to getting the debt paid off.

Nice job!

Sam

Sam

First off, congrats on taking control of your finances. It's great that you are doing this young, before the debt really spiralled out of control.

I have used the Dave Ramsey strategy to pay off a lot of my debt, and it works. I think the $1k savings really helps because if an emergency develops (which it inevitably does) you can grab from that instead of borrowing again from your 401k or putting it back on the card.

After your $1k is met, I think it's important to apply every extra dollar afterwords to debt pay off. Whether it's a 2-5% yield on your money, you're still drowning in a 34% interest on your debt. It cancels out your growth and then some. Pay off the debt, then bank the cash.

Will0957, I agree: I think you're off to a great start. Congratulations. But don't rest on your laurels. Keep attacking this debt, keep working to get it paid off. It may have been iffy to borrow from your 401k to pay down debt, but if you keep that debt off, I think it's actually okay in your case. It's given you the psychological kick-start you needed to really conquer your problem. Just make sure you put that money back in when you get a chance.

Please keep us updated on your progress!

Yes, I'll agree with you on that point. I wanted to be clear to other readers that borrowing from a 401k has time value of money consequences, not just the interest rate.