Reader Question: Is it ok to go into debt if you have a plan to get out?

This is a fair question. Especially because it makes sense to most people. I know some financial advisers are adamantly opposed to debt under any circumstances. I have mixed feelings about this question. I think in the majority of the cases someone would be ok to take on debt in a situation where there is a plan to pay it off within a few (3 or less years). The problem comes when people don’t actually have a plan when they go into debt, or when they take on an excessive amount of debt that couldn’t be paid off in a short time.

The reason I have mixed feelings is because I believe that if someone could just get out of the debt cycle by making payments on what they want before they buy it (also known as saving), they eliminate the risk of throwing their plan out the window when they have another kid or lose their job.

How to make a starter budget

My wife and I are newly weds, and are in our twenties. I would say that we are in the minority of our demographic who actually budget our money each and every month. It is probably the most valuable tool in managing your financial future.

Starting a budget is actually very easy. Instead of looking at it as a mind numbing task, just think in generalities. Here are my general categories:

• Income
• Savings
• Debt
• Monthly Necessary (housing, utilities, etc)
• Monthly Wants (sat. radio, cell phones, etc)
• Cash Envelopes (Eat out, blow, groceries, travel, gas, etc)
• Misc Expenses (pets, continued education, etc)

You can further break your starter budget down as small as you want. I gave some examples of how we’ve broken ours down in parenthesis.

If you don’t start telling your money where to go, you’ll never meet the financial goals you have.

Debt Snowball

There are a number of ways you can start getting out of debt. One of the best ways to stay at it is to develop a debt snowball. Every financial genius has his own version of this method, and everyone thinks his own way is best. Here is an overview of my understanding of the various ways of snowballing.

Smallest to largest balance – Dave Ramsey Method
I first heard about this way of snowballing when I went through Financial Peace University. It makes sense if you believe that controlling finances is more about emotions and behavior than it is about strict mathematics. Proponents believe the thrill of paying off the small debts on your way to the large debts will keep the participant on track. This way was actually my first look at snowballing debt, so I tend to be more sympathetic to this view.

Here is a chart that shows what this tends to look like. The biggest criticism of this method is that it ignores interest rates causing you to pay more interest over the life of the snowball.

Highest to lowest interest payment
Obviously, if the biggest criticism of the smallest to largest debt is that it ignores interest rates, there must be a way that takes rates into account. In this method, you still roll the previous payments into the next payment, but you organize your debts from highest to lowest interest rates. In my experience, people in this camp tend to be very convinced that this is the best way to pay down debt because as your snowball payment gets bigger, more of your money is paying off principle instead of interest. They tend to highly value logic and math in their figuring.

Using the same example as before, this is what my debt snowball would have looked like if I followed this method.

As you can see, this method actually takes longer to pay off than if I were to do a smallest to largest balance snowball. This is one of the criticisms I see of this method. Sure, you may keep higher interest debt around a little longer, but the process of snowballing accelerates payments so much, that I believe the difference in interest paid is insignificant. This seems to be the case in my life, anyway.

Bigger Shovel
- if balance close, pay off the bigger minimum payment first (bigger snowball)
While I am sympathetic to the Ramsey Method, I can’t say I actually followed it. I refer to the way I am paying off debt as getting a bigger shovel. I started off by looking at my debts from smallest to largest. I hated seeing how long it would take me to get a snowball that would have some significance to it. Since the majority of my balances were within a fairly narrow range, I decided to pay off my ford credit loan first, even though it had a 0% rate. Crazy I know. But, of my debts that were within reach of quickly paying off, I chose it because it would start me out with the largest amount to snowball into other debts. As you look at the chart, you’ll notice that I also didn’t follow a true snowball method. I only put $150 of my car payment to the snowball and used the rest to pay for some living expenses that increased.

Here is a picture of what I did to get out of debt. So far, I have paid off Ford, my personal loan, and Sallie Mae 1. At one point I had Capitol One paid off, but I’ve accumulated more credit card debt in the mist of moving twice in two years. I’ll write that off as stupid tax.

Snowflake
Sometimes it can be hard to get started paying off debt. How can you get that first debt paid off so you can start your snowball rolling. One popular method is to snowflake your debt. The idea here is to pull together as much money as you can throughout a given month by saving small amounts of money. One could decide to save all their coin change an put it toward their lowest debt every month. Sure it might only be 5-10 dollars a month, but it makes a big difference in the big picture. Another way would be to skip a cup of coffee one day a week and put that toward debt. Every little snowflake you can push into your snowball will make the snowball a little bigger and roll a little faster.

Which method is closest to the way you plan on paying down debt? If you don’t have a plan yet, which way sounds best to you?

Aug 1 Net Worth

Personal Net Worth. I any time I hear someone talk about that, I imagine them being rich, sitting around in a smoker’s lounge with their cuban’s comparing stories about the quickest way to make a million dollars. However, I’ve come to find it’s valuable for the average Joe to figure out – even if it’s negative.

Why would that be important? Because you can’t get where you are going until you know where you are. I think most people wish they had a million dollars in the bank. That’s the destination or the goal. If you only know where you want to be, how will you ever know how to get there. If you remember from high school geography, it’s impossible to draw a line with only one point. It takes a minimum of two points to make a line.

My net worth isn’t much to speak of right now. It’s only about 6k – a job loss, or an emergency could easily turn that negative. However, it gives me a starting point. I’m going to try to update my net worth every six months so I have a good idea of which way I’m traveling.

It’s really easy to figure your own net worth. Add all your assets up, and then subtract all your debts. Why don’t you join me in the wealth building journey? This way, when we are rich, we can sit around in a smokers lounge talking about who made their first million the fastest.