Happy Saturday, Frugal Farmer readers! Today we welcome a guest post from new-on-the-scene blogger Anum Yoon, who blogs over at Current on Currency. Enjoy!
Imagine you’re a fresh college graduate, with all your hopes and dreams ahead of you. “I’m going to have the most awesome life ever!”, you think. With that in mind, you manage to land a cushy job worth at least $60,000 per year. All signs are pointing in a positive direction.
But then, reality hits you in the face with Thor’s hammer. You remember, with a jolt, that your credit card and student loan debts combined are totaling $50,000. Afraid that your debt will balloon even further, and being all-too aware of how interest rates work, you decide to always pay above the minimum amount you owe every month.
For some reason, though, your financial burden isn’t lightening. In fact, if anything, it’s getting heavier. You suspect that something’s wrong, but you can’t figure out what it is at the moment.
Eventually, your worst fears are confirmed. Upon receipt of your bank statements, you feel shocked at the realization that your debt became $90,000 – almost double your old one!
So what happened? Why did your debt go north, instead of south? Was paying above the minimum monthly debt a shortsighted strategy, after all?
Well, the answer is “Yes” and “No”.
Recommended reading: 16 Common Money Management Mistakes: Take Control of Your Budgeting and Finances Without Giving Up the Things You Love (Money Management And Budgeting – Personal Money Management Series)
The Chink in the Armor
Looking closely at the hypothetical scenario above, you’ll notice that nothing in it suggests that the “character” did anything else with his/her finances other than pay off debt. That’s not to say you shouldn’t pay off debt at all; on the contrary, it’s always a good idea to stay in your creditors’ good books.
But ignoring the other aspects of your finances in a bid to completely eliminate your debt is like trying to restart an old, beaten-down car by only filling up the gas tank – while ignoring the fact that the tank may be leaking, and/or that the other car components may be defective.
In other words, you need to take a good, long look at your finances, and ask: “Is debt my only financial problem?” If your situation is anything like the hypothetical scenario we just discussed, the answer is probably “No.” In that case, you’ll have to buckle up, and do the following:
• Have a Game Plan. Given your current situation, what’s the best way to cut your debt down to size? Start by tracking your cash flow and spending, setting goals like “By X month, my minimum debts should be Y”, and sticking to your debt-reduction strategy until you reach the aforementioned goals. Avoid the mistakes that broke people make.
• Check Your Debt’s Interest Rate vs. Your Savings Account’s. If your credit card’s interest rate exceeds that of your savings account’s interest rate, pay off your debt first. If it’s the opposite, put your money into your savings first. Since interest compounds over time, it’s best to prioritize the one with the higher rate.
• Set Aside Money for Emergencies. An “emergency fund” will help keep you in the black while paying off your debt. Build up at least six months worth of funds, or make it a point to save 20 percent of your monthly income, whichever is more convenient for you. (Laurie’s note: if you’re struggling with a high amount of debt, however, or a high debt-to-income ratio, my opinion is that you should keep $1,000 in your emergency fund while you put the rest toward debt.)
• Have an Extra Source of Income. Thanks to the Internet, you can do almost any job in the comfort of your own home. For starters, you can check out these great sites to find gigs and part-time work that fit your skill set, boost your income, and free up cash for both your debt and emergency fund.
• Rein in Your Spending. Do you honestly need the latest, most cutting-edge phone available on the market right now? If your current phone is still working fine, and meets most of your needs, there’s no reason for you to buy a new one. But I mean, if you need to (which you don’t), consider selling your old phone to reduce the cost. Live only with what you need to live with, and don’t care about what others think about your lifestyle.
Don’t lose hope if your debt seems to have ballooned to the point of no return. There are always ways to return – as long as you’re disciplined, patient and sensible enough to implement the steps outlined above.
Anum Yoon is a personal finance blogger and freelance writer who strangely enough, found her passion for money management through her extensive travels around the world. Since deciding to settle in the US, she has been faced with the task of becoming a responsible consumer with an excellent credit score. You can read her updates on her blog, www.currentoncurrency.com , or check out her latest ramblings on Twitter at @anumyoon.