Keeping Out of Debt - The Speakers

Now THAT’S a system! I’ve got some pretty crappy speakers. They’re from a set I bought almost 15 years ago. They work (well, 3 of them work and that’s enough.) But they aren’t very good quality and I’m not sure how much longer they’ll last. They don’t sound too great, but they are making do.

They definitely aren’t essential, but they sure do make watching movies nicer than just using the speakers on the TV. And for music or radio from the stereo receiver, it’s kinda tough to get that working without them. I do have a portable Sony CD player that gets radio though. That should be enough.

If they go out tomorrow, I’ll be fine. I’ll “suffer” through. But part of me wants new speakers. So now I’ve started allocating some money in a separate account (thanks to the sub-account functionality at ING) and I’m saving up until I have enough to buy them. This will ensure that I don’t get into debt for something I view as a luxury and not a necessity. I’m not saving much, only $25 a month (my entire “fun money” budget), but that will add up over time. Even though it’s in a high interest savings account it won’t earn much quickly, but at least it will earn some interest.

When I’ve got enough money to buy the speakers, I’m going to look for a deal where I can buy the speakers I want, at a reasonable price, and possibly take advantage of a 0% interest and no payments plan. Why would I do this instead of just paying for them outright? I guess it’s kind of like the credit card arbitrage game. I’ll have the money set aside earning interest but I’ll wait to pay off the debt until the end of the 0% deal. I’ve never played that game, but when it comes to a situation like this, I think I would take advantage of it. I have pretty good discipline when the money is out of sight and out of mind. I would just need a reliable reminder when the 0% timeframe is up. I think I can handle that.

The reason the speakers are on my mind now is that in our new house the living room will be wired for surround sound. I haven’t had surround sound for a long time, and I don’t have enough speakers to get it to work now. It’s definitely a luxury, but it’s one I think I would make good use out of.

That’s my plan. It’s not much, but it will be the first time I’ve saved up for a big purchase rather than just splurging and trying to rationalize and deal with the debt later. It’s something I’ve been telling myself I need to do for these kinds of purchases, but haven’t followed through on in the past. Since I’ve been developing my new, more frugal habits, I think I’m ready for this. I’ve kept myself from buying much of anything “for me” for a while now. I think it’s time to start the new habit of saving before buying.

Image Source: jurvetson

Our Plan To Remain Debt Free

Been there buddy! At the beginning of the year, we were able to declare ourselves “debt free”. This was no easy task I can tell you. We still have our mortgage, but we don’t consider it debt exactly. Certainly, it is debt, but it’s at a decent interest rate, we get a tax deduction for our interest payments, and if it’s our only debt, to me that’s “debt free”.

We managed to pay off both of our car loans early. We also eliminated all of our credit card debt this year. We did both of these primarily through some major changes in lifestyle (especially our eating habits - dining out can cost a fortune!)

Now that we are debt free, we have no intention of going back. We’ve made several changes in our life to help us not slide back into that “bad place”. Some of these changes include:

A strict budget - Not so strict we have to beat ourselves for an overage, but a guideline we shoot for with appropriate flexibility in certain areas. The budget helps ensure we live below our means, and that we plan for savings.
Our non-emergency emergency fund - This ensures that we never have to maintain a balance on our credit cards even when we go over more than our flexibility allows (up to a few hundred dollars).
Our emergency fund - This way we can handle even those big cases where we have an emergency. We’re very strict about this being used only for emergencies. Our goal is to eventually build up 6 months living expenses (bare minimum living expenses).
Delaying gratification - Like the iPhone incident of last weekend - I’m no longer going to just indulge myself. All of my upcoming purchases will be planned, and will require taking part of the budget and setting it aside for purchase in the future. This also ensures that when I do indulge myself, it’s not impulsive, and it’s something I’ve researched and know that I want. Oh, and that I find the best deal.
We will drive our cars until they can drive no more - Consumer reports says that can save up to $31,000. For me, a car gets me from a to b, and doesn’t need to be anything fancy. It felt weird typing that, but that’s how much I’ve changed recently. I used to want a flashy car, but now I’d rather save and invest my money.
Find the best deals - I want to understand how much something costs, where I can get the best deal, and make sure I’m not getting ripped off. In the past, I didn’t always bother to research and find the best deal, and convenience was usually the motivating factor. There isn’t anything wrong with convenience, but now I will measure that against other factors.

So, with these things in place, and barring any serious emergencies (like something medical), I think we can remain debt free. We have to remain strict and follow this plan. We cannot allow ourselves to fall back into the “old ways”.

I’d love to hear from other folks who managed to get out of debt. Do you have a plan to remain debt free?

Image source :Daquella Manera

Is Total Debt Avoidance Really Best?

“All debt should be avoided”, “We should all try to live completely debt free”, “Don’t pay interest for anything”.

I feel like I’ve been hearing this debt-free mantra everywhere lately. Living debt-free is a fantastic goal to strive for.

Debt, as a general concept, is a negative thing to have. Having no financial obligations and enjoying complete freedom in how you spend your money is ideal. But when going into debt is the only way to achieve something you feel is truly worthwhile (within a reasonable time frame) is it still to be avoided at all costs?

I think there is a balance to be found; a balance between living below your means and enjoying life and what’s important to you. While debt can have a negative impact by decreasing your ability to build savings, some debt can actually enable you to further your career, build wealth, and acquire property. Following blanket statements like “never incur any debt” could mean missing out on these opportunities.

Let’s look at two situations where a no-tolerance debt avoidance policy could mean serious sacrifices:

Higher Education

Graduation Day! Many people rely on student loans in order to attend college. College is expensive and many students straight out of high school have a relatively low earning potential. At that age, it can be a real challenge to have the money to attend a university without financial support. Even for those who do get scholarships and grants sometimes it isn’t enough to cover all the costs.

Should people who do not have the money saved up to attend college simply forgo seeking that higher education to avoid student debt? Is remaining completely debt free worth passing up the opportunities having a degree could give?

Granted, you don’t need a degree to do well for yourself in this world. But a degree does help open doors, especially when more jobs are requiring a college degree now. An education can increase your earning potential and allow you to pursue specific career aspirations (like becoming a doctor). Being saddled with debt after leaving school is difficult but if having a degree can help you reach your career goals (and potentially your life goals) perhaps that is a debt worth enduring.

Mortgages

Many people simply can’t afford to buy a home outright. Home ownership is a common and deeply ingrained dream for many Americans. The reasons for wanting a home vary and in my opinion home ownership is a good goal to have. Over time, real estate generally increases in value and there are many benefits (not only financial) to being a home owner.

Should families whose dream is to have their own home really postpone home ownership until they can save up the entire cost of a home to avoid a mortgage?

New Home I was able to find some 1960’s fixer-upper homes for sale for about $80K near the city. That was the absolute low end of the scale excluding mobile homes and condos. $80K is a lot of money to save up in addition to other saving goals like retirement, especially if you earn less than the median household income in our area of $43K a year. It can be done, of course, but it would likely take years and serious sacrifice.

We live in a modest home in the suburbs outside a major city. The homes in our neighborhood are about 8 years old and average for around $160K now. If we were to save aggressively - $1K a month - it would take us almost 17 years to reach that amount (assuming 4% interest and 3% inflation). That’s a long time to wait just to avoid that mortgage and every year home prices continue to rise.

For me, I’d choose to get a mortgage I can safely afford and pay it down aggressively. Yes, I’ll incur interest and that is “wasted money” but I see it as a fact of life in order to achieve the goal of home ownership for my family. In my mind it becomes a choice between wasting money paying interest and wasting time by holding off for years until I can afford to buy the home in full. I guess it depends on what you see as more important.

Really, it boils down to choice and finding what is important to you. Blanket statements like “never go into debt” might not be the best path for everyone if that means missing out on potential wealth building opportunities like going to college or owning a home.

I think the key is allowing for debt that is “wealth-building” while trying to pay it down as soon as possible. Avoiding all other debt that decreases in worth (e.g. credit card debt and car loans) is absolutely essential.

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The Downside to Debt Consolidation Loans

I would like one loan for everything please! When I started my first job after college, I didn’t own much. I had my car, some hand-me-down furniture, some clothes, a TV and VCR, a computer, some books, and a variety of other small things. I didn’t have much in the way of assets, and the furniture I had was really starting to show it’s age.

I managed to get a good job and it payed well. Considering I had so little when I moved, and I thought I was doing well, I decided to “move on up”. I upgraded my TV from a 13″ to a 27″. I bought new furniture, including new couches, coffee table, entertainment center, and end tables. I bought some movies, new books, and a smattering of other things. Before I knew it, I had $12,000 in credit card bills. By some people’s standards, that might not seem like a lot. For me at the time, it was huge. My father had always told me to avoid debt, and never carry a balance on your credit card. He’s never had to pay a finance charge on his credit card before. I hadn’t either up until this point.

I knew I had to find a way to pay the debt down. So I took out a debt consolidation loan against my car. Everything worked out fine, and I managed to get out of debt at that point fairly painlessly. I didn’t learn the lesson completely (I’ve had debt since this incident), but in my case the debt consolidation loan actually worked out pretty well, and saved me some money in the end.

Now, I’ve got a friend who has never handled his money well. He’s made some bad decisions in his life when it comes to finances. He’s actually a very, very smart guy, but he just doesn’t always think when it comes to spending money. I guess I’ve been there too, so I don’t judge him, but he did make a decision that confused me recently.

Things had been going well for him for a bit, and he just got a debt consolidation loan. This loan lowers his overall payment requirements each month, has a lower interest rate, and helps him get all his debt into one place. It looked like a pretty good plan to help him get out of debt.

But then, shortly after he had everything setup, he went out and made some purchases on his newly paid-off credit cards. After going through all the trouble to consolidate his loans he started filling up his credit cards again and created even more debt. He purchased some things that he wanted, but couldn’t afford until he had more room on his credit cards. The things he bought were far from necessities.

Now he has to worry about paying off both the loan and the new credit card balances. It seems that he’ll be in debt for a while longer. He understands what he’s done, and that it’s not the best financial move, but it doesn’t seem to change his behavior. Instead of working to pay down that loan, he just compounded it by adding even more debt.

Normally I wouldn’t advocate cutting up your credit cards. We use our credit cards extensively, but we ensure that each month we don’t carry a balance so we avoid paying finance charges. If you use your credit cards responsibly they can be a very convenient and useful tool. If you have rewards, you can even get some cash back or some other type of reward for using them. In this case, I think my friend is too tempted by available credit and might be better off just cutting up his cards.

If you get a debt consolidation loan, make sure you keep these things in mind :

Make sure that the deal you are getting is actually giving you a lower interest rate than what you are paying now. And make sure that there aren’t any unnecessary fees.
Setup a budget that allows you to always make the loan payment and stick to it. This will help ensure you aren’t living outside your means and that you are paying off the loan.
Stop using your credit cards until the loan is paid off. Maybe stop using them entirely if you don’t think you can handle the temptation.
Pay off the loan early if possible. I paid my loan off about 6 months early to get out of some of the interest. It’s definitely a good goal to have.

Debt consolidation loans can work for you, but only if you work within some basic guidelines and exercise your self-control when it comes to your credit cards. According to Bankrate.com, 70% of people who get debt consolidation loans have the same, or higher, debt loads 2 years after they get the loans. If you think a debt consolidation loan would work for you, do some research before you commit to anything. Get some help from a financial advisor if you can. Don’t wind up in the 70% that don’t reduce their debt at all.

Image Source: SqueakyMarmot

The Non-Emergency “Emergency” Fund

That sign’s pretty clear I’ve Paid For This Twice Already’s article on giving yourself a payday advance is a very good concept. It’s easy to see why payday loans have such an allure for those strapped for cash. For people living paycheck to paycheck tapping their emergency savings to help them get through the tighter periods can be very helpful. It acts as a “payday loan” without paying the high fees typically associated with those short term loans. I am all for avoiding payday loans.

However, I think using your emergency fund for these types of short term loans can start to erode the meaning of that fund. Ideally that fund is for emergencies. For me, that means serious (and hopefully rare) problems like unemployment, car repairs, huge medical bills, and critical home repairs. We want this fund out of our immediate reach in a high interest savings account. It needs to feel untouchable. I fear that if we got used to withdrawing from it for small, non-emergency things it could create a “slippery slope” that blurs the boundaries. It loses it’s distinction as the almighty emergency fund and becomes yet another savings account for me to use at my discretion.

Although running short on money before the next paycheck can feel like an emergency, technically it is simply going over budget for that time period. Instead of pulling money from our emergency fund, we’ve found that it’s better for us to keep a fund specifically for “everyday” shortages and frequent transactions. We call this the overage fund.

Let’s say you find a spectacular sale on paper towels and you stock up, spending more than you have set aside for the household that month. Maybe it’s time to get your oil changed but fuel costs ate up the car budget. Or perhaps the first part of the month has a higher proportion of the bills and you have unexpected expenses that result in that paycheck running short. Are these really emergencies? In most cases, probably not. But they could put you in a situation where you could be in a real pinch or even go into debt. These would be cases to use an overage fund.

Our overage fund is a couple hundred dollars and we keep it in our normal checking account as a cushion. Basically it’s a small amount of savings that we dip into whenever we have to and replace as soon as possible.

We use the overage fund for two main reasons:

As a temporary loan while waiting for the next paycheck
To avoid interest accruing debt when we go over budget for the month

Temporarily using money from the overage fund can help you make it to the next paycheck without going into panic mode. Mostly we use ours to help us avoid debt by using it to supplement months where we go over budget. We can pay the extra expenses from our overage account without having to keep a credit card balance. This saves us on potential interest charges. In the upcoming months we make sure to pay back the amount we took by reducing our budget accordingly.

An overage fund can be in any form you feel comfortable with. Maybe this fund is just the cushion you keep in your checking account. Maybe it’s a savings account from which you can easily transfer funds. It just needs to stay close to home so you don’t have to wait for the funds to transfer if you need them quickly.

Always aim to keep a certain level in this fund. It could be something like $200. If you go below that amount work to stay under budget in order to replenish it. If you are using it as a floater until the next payday be sure to replace the funds immediately when you get paid next. If you have to tap these funds due to unexpected bills pushing you over budget it should be a priority to pay them back, just like other debt payments. Only this time you’re paying yourself back and not the bank.

Whether you are pulling cash from your official emergency fund or an overage fund you are using your own cash instead of relying on a payday loan or credit card. It’s a very positive thing that can help keep you from paying fees and interest. Using this method, we’ve been able to stock on some sales, go out to an unexpected dinner with friends, and manage to pay for our car registration (which we had completely forgotten about) without having to dip into our emergency fund or leave a balance on our credit card. Within a month or two we’ve usually managed to reduce our spending enough to replenish our overage account so we’re ready for the next unexpected expense.

Image Source: StuSeeger

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