Emotional debt and savings prioritization

I finally found my way out of debt a couple of years ago, and I’ve stayed out ever since, and I can tell you: it’s made me much happier. It’s actually improved my quality of life. Some people can tolerate more debt than others, and some debts are less bad than others, but if you’re in debt and you want out, here’s how I went about it.

Some of your debts are more depressing to you than others

If you identify which debts are getting you down the most, you can do two good things for yourself, for the price of one.

Think about each of your debts, one at a time. Did the student loan give you more of a trapped feeling than the car loan? Or was it the credit card debt that most freaks you out, because that nice introductory rate you have is going to expire in a few months? Generally, debts are what most bother us, but what about savings? Is not having an emergency fund stressing you out even more than being in debt? This is valid, too, because it’s a trade-off: you get out of debt by paying it off with money you could’ve put into savings. At some point, you may feel your debts are manageable and will be paid off soon enough, and decide you’d rather put most of your extra money into savings instead.

Make a priority list. Put the item that bothers you most at the top. Then the second worst offender, then the third and so on. Now you know what order of debt elimination/savings building will not only improve your finances, but give you the added benefit of reducing your debt stress and making you happier. Now you can look at ways to tackle “first things first”.

The snowball method

The snowball method of getting out of debt is where you tackle one debt at a time. You pay the minimum on all the others, but throw every extra penny you can at the worst debt. The way you were supposed to prioritize debts was by how much they were costing you over and above what you owed. All I added to that system was emotional considerations, because some of my debts were equally costly and I had to find another way to determine which one to attack first. I had no idea at the time how much more positive it would make me feel, doing it that way.

Look at your priority list. If you put student loans at the top of your list and credit cards somewhere down the line, this opens up a couple of options. The first is: can you move the loans to an interest free (or very low interest) credit card that you can pay down quickly? This was a lot easier to get a couple of years ago, before the recession, but it’s still worth looking into.  If not, you still have the second option: pay the minimum on all your other debts, and put the bulk of your extra money into paying off student loans.

What if you picked savings as your first priority? In that case I would still recommend paying a bit more than the minimum on any debts that are accruing interest monthly. Credit card minimum payments are designed to let your balance keep getting larger. You want to keep those debt balances falling – pay enough to make that happen. But otherwise, throw all your money into savings. If you reach a point where you feel okay about your savings, switch to paying off the first debt on your priority list. Remember: if your debts are costing you 18% and your savings is only earning 1.5%, paying off the debt will cost you much less in the end. But if you’re really feeling the need for ready cash you can turn to if the car breaks down or, heaven forbid, you lose a job, the emotional side of it has to be considered too.

Consolidating your debts

A few years ago, it was much easier to consolidate debt on your own. If you had good credit, you could bounce a balance around on introductory zero interest rate cards until you paid it off (that’s what I did – never paid a dime of interest). If you owned a home, you could refinance and pay off debt with that extra money, so long as you knew what you were getting into with the second mortgage. Now, these options are much harder to come by.

The emotional benefit of consolidating debts is that you have fewer debts to think about. Fewer people to remember to pay every month. Fewer payments to remember making when you wake in the middle of the night thinking, “Oh, no, did I pay that one on time?” And if you have trouble maintaining disciplined spending habits, transferring debt off of a credit card and then closing that card will slow you down.

• Balance transfers. You may not be able to transfer anything to a zero interest rate card anymore, but what if you have debt on three credit cards, and one of them has an interest rate that’s 5% lower than the highest of the three? Can you transfer everything to that card and just work on that payment? If you need a bigger line of credit to do that, see if you can get one – it might even get you in good with that creditor and get you a special deal with even more savings. Often, balance transfers will still get you a reduced interest rate, which brings down your overall loss of money.
• Borrow against your life insurance? If you have a policy with a cash value, you can borrow against it with much lower interest rates than most credit cards offer. And there isn’t a rush to repay it (though you should be aware that when you die, any outstanding debt will be taken out of it before the beneficiary gets paid).
• Family loans. Debt between family members can create extreme friction, but if you’re all basically reasonable, responsible people, and someone’s willing to lend you money so you can pay off high interest debt and pay them back at lower or no interest, here’s what you need to do: write it all down. Have everyone sign it, too. It may seem formal, but you don’t want to hear six months down the line, “I know we discussed X, Y and Z, but I thought in the end we decided on A, and you seem to be doing B.” Paying off debt takes time, and memories are imperfect. Getting it in writing not only ensures against disputes in the future, it reinforces in everyone’s mind what the terms are. Include terms for the possibility that you have to delay repayment. What if things go from bad to worse, and you need a month or two off of paying this debt? How many months are you allowed? Do you pay interest later on to make up for that? Make sure everyone is on exactly the same page.
• Borrowing from your 401k. This is possible to do, and it might be a good (or at least, better than the alternative) solution for many people, but there are a number of downsides. Rather than try to cover it, which I really don’t feel qualified to do, I’m going to suggest you seek expert advice before taking this route.

Saving and earning more

The more income you have, the quicker you can pay off debt. Look into expenditures you can do without – restaurant eating, payperview, magazine subscriptions. Even saving $30 a month enables you to reduce debt by $360/year plus whatever interest that $360 was accruing. If you can save a couple hundred a month, even better. Putting yourself on a strict budget doesn’t have to be depressing, if you learn to get excited at watching those debt numbers steadily drop.

Consider taking in a roommate, or an additional roommate if you already have one. Consider selling junk via a garage sale, Craigslist or eBay. And what if family or friends can’t lend you money, but they’re willing to watch your kids to save you the cost of daycare? If you can’t save money by buying groceries in bulk because you live alone and can’t use it all, what about joining forces with some friends or family and splitting the purchases?

Make sure you’re bringing in all the money you can. A second job is not realistic for most of us, but can you do what you do for salary as a consultant on the side? Or do you know a musical instrument or sport well enough to give lessons for a bit of extra money? Many years ago, I made some money by helping people punch up their resumes – making what they’d done sound the best it possibly could, without exaggerating. You may think you don’t have any skills people would pay money for, but you probably do.

Check our Frugal section for ideas, but always keep thinking outside the box and reviewing your situation, and asking yourself questions like “Do I really need this expenditure?” and “Could I charge someone money for this?

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Posted in Frugal on November 2, 2009