Now that you have Stopped Contributing to the Problem, Reduced the Cost of Debt, and Freed up Some Extra money, all as outlined in Part I, and then picked a Strategy for Paying Down Your Debt in Part II, it’s time to look at the third and final installment of this series for Caveats, Tips, and some glimpses of what’s to come here at Don’t Feed the Alligators.
- In Part II, I used a mix of consumer and investment debt to outline the various kinds of debt reduction plans. In reality, these two types of debts are not created equal, and as such should not be treated in the same way. I generally would not advocate including things like mortgage and student loan debt in an aggressive debt paydown plan without first carefully evaluating your current, near term, and long term situation and considering whether your money might work harder for you elsewhere. This is on my list of topics for future exploration here.
- I have made no adjustment to the paydown plans listed in Part II to account for the tax advantages of deductible interest payments. For example, a student loan with a 6% interest rate only actually costs something like 5.1% after taxes for someone in the 15% marginal tax bracket, and even less if you can deduct it from your state income taxes as well. So if you have a credit card with a 5.5% interest rate then it should be above the 6% student loan in your debt paydown plan.
- Every little bit counts. Anytime you get any extra money, from whatever source, commit to applying most, if not all, of it to your debt. If you get a bonus or a raise at work, a tax return, win your kid’s soccer raffle, etc., apply most of it to your debt reduction. You were probably doing just fine before you got the extra money, so do yourself a favor and reduce the time it will take to get out of debt. Not only will you get this money back later, but it will actually be worth more since you will effectively be “investing” it in your debt reduction at whatever the interest rate of the debt you carry. Let’s say that you shave 2 months off of your debt reduction plan with money from your tax return. In the 2 months that follow your get-out-of-debt day, you should actually end up having more than the tax return amount.
- Every little bit counts, Part II: Given that many people now have the ability to make free payments to their debts at any time, day or night, through online billpay offered by most banks, then you can contribute early and often. Did you find a $5 bill on the ground this morning? Put it towards your debt reduction. Did you win $10 on a scratch ticket? Put it towards your debt reduction. Did you save $3 by using a coupon at the supermarket? Put it towards you debt reduction. This concept, know by some as “snowflaking” (a term which the Get Rich Slowly Blog indicates originated at the i-Village Debt Support Group, and about which I’ve Paid Twice for this Already has written), can really make a difference over time, and it keeps you in the habit of focusing on your debt reduction.
- Many people are in perpetual debt because they have no avenue, other than credit cards, for dealing with unexpected expenses. This is why you should have a modest emergency fund available to avoid just such a trap. As you start your debt reduction plan, take some of the extra money and use it to start an emergency fund of $1000. Keep this money somewhere that you can get to it quickly, but not somewhere that makes it too convenient to access (like in the account that links to your ATM card). Right now you can earn $25 at ING Direct for keeping just $250 in the account for 3 months. Let me know if you would like a referral! I will talk more about a longer term emergency fund in a future article here.
- If you have to use this money to pay an unexpected bill, consider whether it was really unexpected or whether you were just not prepared for it. Getting a speeding ticket is an unexpected expense, but getting your annual car insurance bill is not. If this expense is expected, but does not correspond to your normal pay cycle, consider putting some money away each month so that you can deal with it when the full bill comes. I’ll talk more about this in a future article here.
If you have read this far in the first Trilogy at Don’t Feed the Alligators, I thank you for taking the time and appreciate your readership. Good luck with your debt reduction plan, and as always, let me know what you think or if you have any other questions by Commenting below.
See also: Getting Out of Debt, Part I and Part II