While it may be true that money won’t make you happy, it sure as hell won’t make you sad.
Now that we’ve budgeted, we’ve cut expenses, and we’ve looked into various ways to make more money, we should be running at a surplus every month. So, what do we do with all this “extra” money?
You will fall into one of the following two groups: Group A has debt (credit cards, student loans, personal loans, car loans) to pay off. Group B is debt free and needs to learn to save and invest.
Group A: You guys are going to take every extra penny you can squeeze out of your budget and you’re going to throw those pennies and dimes and dollars at your debt. Sit down with a notepad and write down all of the creditors you owe. Then list them in order of smallest amount, to largest.
We’re going to use Dave Ramsey’s Debt Snowball method (I’ll explain in a minute) to get rid of these debts.
Making a monthly payment sure does sound like a good deal in the beginning. Department stores will let you take home HDTVs, laptops, clothes, Playstations, and anything else you want, in exchange for a low, low monthly payment. But stop for a moment and calculate the interest payments you’re making on all of that stuff. Reader Bill (@drnoise) had a credit card with a $500 limit. He used it to buy some tools for his job a few years ago. He’s been making monthly payments since and just paid off that credit card three days ago. He ended up paying a total of over $1,300 for those $500 tools.
That is not how you build wealth.
Now that I’m no longer making monthly payments on my car, my credit cards, or any other debt, I’m able to save and spend and donate all of that money however I see fit each month. There is a wonderful feeling of security and safety that comes with not living paycheck to paycheck. It’s completely changed my life and daily attitude. And you can feel that security too.
Bill started his Debt Snowball four months ago when he and I were talking and he asked how I got out of debt. So, let me share with you too how it works.
The Debt Snowball method is taught by financial adviser Dave Ramsey. I did not invent this. But Dave advocates preaching it as much as possible, and I’m proof it works. So here we go:
- Line up all of your debts from smallest amount to largest amount. Do not worry about interest rates.
- Pay the minimum amount due on all debts except the smallest one. We’re going to take all the extra money we can find, and focus on paying off the smallest debt first and fast. The goal here is to pay off the smallest debts quickly. Not only is this going to free up more cash in our monthly budget, but it’s also going to help motivate you to get out of debt, and start building wealth.
- After you pay off the smallest debt, take the amount you were paying on that, plus your extra money every month, and roll it over to the next smallest amount. When a snowball rolls, it picks up more snow with each rotation. That’s exactly what we’re doing here. Each time we pay off a debt, we’re going to take the amount we were paying towards it, and roll it over into the payment on the next debt.
Using the Debt Snowball last year, I paid off all of my credit cards within six months. Then cut them up. After that, I took the payments I was using on my credit cards, and rolled them over into my monthly car loan payments. Suddenly, instead of paying $200/month on my car, I was paying $600/month. At that rate, it doesn’t take long to save a ton on interest payments, and pay off the loan completely.
Before beginning your Debt Snowball, many people advise you first save up a small emergency fund. This is a $500-$1,000 buffer in a savings account. This isn’t for clothes or vacations or awesome sales on Amazon. This is for emergencies only. Flat tires, broken windshield, extended illness where you must miss work.
We’ll talk more about emergency funds in the next post. For now, start compiling your list of debts.
Group B: Congrats on having no debt! Now we just need to be smart about how we save and invest our extra money. Starting with the next post, I’ll discuss various savings accounts, retirement accounts and investments for your money.
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What if we only have 1 credit card…with a good amount on it? Just keep chugging along paying as much as possible on it?
@Cait, if you only have one debt, yes. Pay as much as you can to get rid of it as quickly as you can, so you have that extra money each month to save and invest.
Here’s a question. I know most of the “FREE credit reports!!1!” online are scams (or at least not free) but I would really like to be able to check my credit history. I’ve recently come up with some medical bills that my family said they would take care of, and “take care of” apparently meant “pretend they don’t exist.” I’m a little scare to see what else I might owe, but I’d rather not end up with an even worse credit score. Advice?
The Debt Snowball sounds really strange at first, but once you see how it works, you realize how great it is.
The only free place to get a credit report is from http://www.annualcreditreport.com, which, as I understand, is run by the federal government. You can check each of the three credit bureaus once a year. I have my Google Calendar set up to remind me to check one of the three every 4 months on a rotating schedule. That way if someone steals my identity, I will eventually find out. Molly, the credit report will show any outstanding debts, including the medical bills if they have been sent out for collection.
To get your FICO score, which is used to tell lenders how much of a credit risk you are, you have to pay for it. There are some decent free FICO estimators online that can give you an idea of what your score would be.
Thank you very much for the credit report tip, Abreena. I selected one of the credit reports, and it showed (as I figured) another outstanding bill I didn’t know about until today. At least I know what I’m dealing with now.
I tried one of the FICO calculators, but I have a feeling my real credit score isn’t as generous as they’re estimating.