Rational Budgeting- Dealing With Debt

Beyond Saving's picture

 

Surveys indicate that around 40% of Americans have a monthly budget. I suspect that a good portion of those are lying or stretching the truth when it comes to defining a monthly budget. On average, Americans save well less than 5% of their income while personal debt remains at high levels. So suppose you are one of the millions who has been spending more than you make and have found yourself in hole, which direction do you dig?

 

On the surface, budgeting is pretty straightforward. You make $X so as long as spending<X your headed in the right direction. If spending>X then you either need to reduce spending or increase X. What is quite simple in theory proves quite difficult to implement in real life. So how do you get control of your personal finances so you can make rational economic decisions? 

 

Where did my money go?

 

Before you do anything else, you must know exactly how much money you are getting and exactly where every penny is going. There are a lot of resources available for free on the internet. I use Quicken because it is extremely helpful when it comes to doing taxes. Intuit also offers a free service at www.mint.com which does an awesome job helping you keep track of all your electronic transactions. However, if you are digging yourself into a debt hole internet service is one of those luxuries that is easy to cut out and doing your personal financing on a library computer isn't the best idea. Go to a dollar store and invest in a pocket notebook.

 

If you don't have an accurate budget, chances are you don't know what you spend your money on. For the next month, carry your pocket notebook and every time you spend money, write it down. It will help if you categorize each page of the notebook. For example, you might have one page for groceries, another for gas, entertainment, household supplies, auto maintenance etc. When you spend money sit in the parking lot for an extra minute and write down how much you spent, on what, on the appropriate page. I also recommend you keep your receipts for future reference. 

 

Even after a couple weeks of doing this, you might notice a few of the extra things that are costing you more money than you thought. Once you have enough data create a monthly budget. List how much money you spend each month in each category. 

 

 

Prioritize, Budget & Control

 

Next, list your expenses in order of importance. Food, lodging, transportation, utilities and other necessities should be at the top, then savings, then debt and luxuries at the bottom. This should allow you to see which areas you are overspending in. Analyze each category and look for places to cut. Start with the easy things, do you really need to spend $1.25 for gas station coffee everyday? Are you eating out a lot? You blew $15 going to the movies? Redbox is $1.

 

Now it is time to make a formal budget. List how much you believe you should be spending in each category. The total should come up to be less than your net income. If it isn't, you might need to make more extreme cuts in your larger budget areas like food and lodging which I will get into later. This is simply an exercise of creating a realistic plan of where you will be spending your money in the future and addressing shortfalls before you actually spend the money.

 

Once you create a plan, you have to stick to it. This can be exceptionally difficult as you might be tempted to spend outside your budget and it is virtually impossible to plan for every single expenditure. There are a variety of methods to stick to your budget and it really doesn't matter which you use as long as it works for you. I am a proponent of the envelope system.

 

Then envelope system is a simple concept. When you get your paycheck you cash it and divvy up the money into separate envelopes based on your budget. If you determine you can spend $50/week on food put $50 in an envelope and mark it food (or $100 if you are paid bi-weekly). Have an envelope for each category you made in your budget, including one for entertainment. When you purchase anything, take the cash from the appropriate envelope. When the envelope is empty, its gone. Sorry, you can't buy anything in that category anymore. The whole point is to earmark all of your money for particular uses.

 

For those irregular but planned expenses, set aside money. For example, I purchase clothes once a year (I hate clothes shopping), so once a year I buy enough to last another year. Put a little of every paycheck in a savings account for those expenses and plan in advance which week you will do the shopping. 

 

Now initially you might discover that your budget was unrealistic. Maybe you empty your envelopes too fast in some categories, while others you have a surplus. Take this opportunity to revise your budget. Within a couple months your predicted budget should match closely with your actual expenditures. 

 

 

 

The 800 Pound Gorilla

 

Ok, so now you have a budget planned and are sticking to it. Now you know how much surplus you have to save and deal with your previously accumulated debt. The absolute first thing you need to do is pay yourself. Before you pay any of your debt, build an emergency fund. You need to have at least $1000 to cover unexpected expenses like car problems or minor medical bills etc. Build up that fund as quickly as possible. Once, you have $1000 in that fund you can start paying off your debt while continuing to add a smaller amount to it each month. 

 

There are a number of strategies for dealing with debt depending on how much you care about your credit rating and what type of debt it is. If you are having a problem with large debt, credit cards are most likely involved. Obviously, it is best not to default if it is possible to make your monthly payments while filling your emergency fund and meeting your budget. There is a good chance you can't.

 

Start by listing all of your debts. First priority is secured debt like a mortgage or auto loan. If you don't pay those you lose things you need so they take priority. However, in some cases they can also be the largest culprits. If you are completely unable to balance your budget you may have to take radical steps regarding your mortgage or auto loan. Student loans might be part of the issue but if you call your student loan company they are very easy to work with in regards to setting up an income based repayment plan or temporarily postponing repayment. Call your student loan vendor, explain your situation and they will be able to explain your options.

 

Credit cards. The bane of middle class Americans. The great thing about credit cards is that it is extremely difficult for a credit card company to take anything from you. They can and sometimes do sue but credit card companies prefer to work with the customer because the legal path is usually unprofitable for them. If you have already defaulted or know you will be forced to default you will need to call each credit card company and negotiate. There are plenty of companies/organizations that "consolidate" your debt or negotiate on your behalf. You are far better off doing it yourself.

 

If you have only missed one payment, credit card companies are unlikely to be willing to negotiate. After 2-3 months they become very willing to negotiate. The reason being is that after 6-months credit card companies charge off the account. That means they accept it as a loss, write it off on their taxes and sell the account to a collection agency for pennies on the dollar. This is bad for them because they take most of what you owe as a loss and bad for you because it really hurts your credit score for the next 7 years and a collection agency is far more likely to pursue legal action.

 

Don't dodge the phone calls or try to hide from your creditors. Talk to them, explain your situation, explain that you do want to meet your obligations and request a payment plan that fits into your budget. They will be willing to reduce your interest rate and forgive late fees in exchange for a fixed payment. Talk to the companies and see what kind of agreements they are willing to offer. Make detailed notes but don't agree to anything yet. Even when they say "you might not get this deal later" they are lying, in fact, when you call later you might get a better deal. The goal here is to simply get an idea of what types of minimum payments you can get and what the interest rates will be.

 

There are a couple schools of thought on prioritizing which credit cards to pay back first. It would seem that paying back the one with the highest interest rate first might be the best idea and from a purely financial standpoint, it usually is. However, many financial experts actually suggest you pay off the smallest balance regardless of interest rate. This is beneficial for two reasons, first it gives you motivation when you successfully pay off a debt. The psychological effect is important in helping you maintain the drive to pay off all your debt and avoiding depression. Second, it provides your budget with more flexibility. Once you pay off a debt, you no longer owe that minimum payment every month. This allows you to take the money you were paying towards the smaller debt and increase the speed in which you pay off your next debt or if your emergency fund is growing too slowly, you can apply part of that money to help build that more quickly.

 

Once you determine which cards you are paying off first call the companies and set up the payment plans. If you are unable to meet the minimum payments for all the cards contact the ones you are unable to afford and tell them. Offer to pay a smaller minimum payment and explain that as money is freed up from paying off your other debts, you will pay more towards them. You might have to play hardball and push that 6 month line, but every time they call tell them the amount you are able to pay each month.

 

 

 

Extreme Measures

 

What if you do everything I listed above but you are still unable to have a balanced budget or create a plan to pay off your debt? You might have to consider making a radical change in your life. Maybe you have to move to a place with cheaper rent or if you own maybe you have to sell your house. If you are living in a place that you can't afford you probably know it in your gut even if you haven't admitted it to yourself. If you have a job and have found yourself up to your neck in debt you have been living beyond your means and changing your lifestyle is going to be necessary. The most important and in some ways the most difficult thing to do is to change your lifestyle.

 

If you make $20k a year and you are paying $1000/month for rent or a mortgage the math isn't going to work. You need to find someplace cheaper to live or maybe get a roommate. Maybe you have to go live in the slums of your area for $400/month, exchange your house for a mobile home or even live out of your car/homeless shelters for a bit. What is necessary really depends on your personal situation, but it is important to be brutally honest with yourself.

 

The basic question is how far are you willing to go? If you are willing to go to extremes it is possible to live on very little money. Your food budget can be substantially cut by cooking for yourself and eating things like beans, rice, pasta, peanut butter etc. If you swing by your local food shelf you can cut it back even further (just remember them when you get back on your feet and pass the charity along). Do your shopping at a salvation army or goodwill. Clip coupons, but only for things you needed to buy anyway. Wash your laundry by hand, take cold showers, change your own oil etc. Any time you are going to pay someone to do something ask if you could do it yourself. 

 

Similarly, how far are you willing to go to increase your income? Are you willing to get a second job? Maybe do some side jobs for cash? Let people you know that you are trying to make some extra cash to pay off debt, maybe they need something or know someone who would pay you to do something. Donate plasma, plasma places will pay $20-$30 per donation. At twice a week that is $80-$100/month a decent amount to be applying to your debt. 

 

The further you are willing to go, the faster your debt will be paid and/or the faster you will save money. What is your ultimate goal worth to you? Only you can answer that question.

 

 

I just usually go with my own taste. If I like something, and it happens to be against the law, well, then I might have a problem.- Hunter S. Thompson

harleysportster's picture

Medical Bills

Good points Beyond. I have a couple of questions.  

I have heard from several people (it is one of those, ask five people the same question and you get five different answer scenarios) that medical bills do not go against your credit and then I have heard some people say that they do. Which is it ?

I have heard that as long as I am sending the hospital a monthly sum to pay off the debt, they can not send it to collections. However, the hospital staff tried to tell me there had to be a minimum and they had the right to refuse the forty dollars a month that I have been paying to them. Is it true that as long as I am sending them SOMETHING, at the beginning of every month, that they have to accept that or no ?

These are two questions that I seem to have trouble finding an answer to. Even searching on the internet has given me so much contradictory information that I am not sure. It almost seems to vary from state to state.

Nearly everyone that I have talked to tells me a story like "Well, I never paid my medical bills and they never came after me,". or they tell me about a family member that never paid any of their bills after surgery.

Seems like medical bills are in some sort of weird, ambiguous category.

As far as credit cards go, I consolidated those bills about three years ago, cut them all up, and simply saved one for emergency situations.

“It is proof of a base and low mind for one to wish to think with the masses or majority, merely because the majority is the majority. Truth does not change because it is, or is not, believed by a majority of the people.”
― Giordano Bruno

Tapey's picture

All solid advice. Though I

All solid advice. Though I would imagine better advice is to avoid getting into debt in the first place. For me there are only two things for which I would whilingly put myself in debt for. Firstly land, I can see myself buying property with debt. Secondly a car, but only if public transportation is not avaliable (or way to expensive that a car becomes cheaper than it), not when public transportation is inconvienent but just not an option. If you are finding yourself geting into debt with everyday living expenses because something breaks you should be cutting your expenses. Recently I had my car and my computer break in the same month, but because I had been responsible with my money I was able to pay the R9000 ($1100) without having to borrow a cent and I didn't have to wait to have them fixed.

 

However what I am thinking about doing is buying some furnature or whatever I need with debt and pay it off even if I could just buy it so I can establish a credit record with the bank. So when the time comes for me to buy some property they at least have my name on file. But I don't know how worth it that is.

 

Whatever goes upon two legs is an enemy.
Whatever goes upon four legs, or has wings, is a friend.
No animal shall wear clothes.
No animal shall sleep in a bed.
No animal shall drink alcohol.
No animal shall kill any other animal.
All animals are equal.

Beyond Saving's picture

 Harley, medical bills

 Harley, medical bills don't show up on your credit report- medical collections will. Most companies don't take medical collections as seriously as they do other collections and if the rest of your credit report is good your score can easily remain in the high 500's-low 600's. Not good enough to get the highest limits and best deals, but good enough that it won't prevent you from getting most credit.

 

Whether or not a medical bill is turned over to collections really depends on the hospital and state laws. Most states do have some form of "good faith" clause that protects medical bills from going to collections if you are paying a reasonable amount each month but the size of that good faith payment varies by state. If you call a lawyer who deals with bankruptcies in your state they should be able to tell you if you really need to be concerned about it being sent to collections or if the person you spoke with was just trying to scare you, a very common tactic in collections.

 

It is possible that those who have stories about not paying a bill and never having anyone come after them did have their bills sent to collections and they simply didn't know it. Collection companies buy debt in bulk for pennies so they aren't concerned with collecting from every person on the list. They pass out lists to the collectors who then start calling and pestering you. 

 

Since suing is rarely profitable most collectors will generally be satisfied with annoying you, threatening you and trashing your credit unless they have reason to believe that you have enough assets and the bill is large enough to justify a lawsuit. Once they make whatever is an acceptable profit to them, they bundle the remaining uncollected debts in a box and toss them in a closet and move on to the next list. They may or may not send have someone revive them if business gets slow or perhaps use them for training. Until the statute of limitations passes, that debt is collectible and can come back to haunt you years later.

 

In fact, certain collection agencies purchase old debt from other collection agencies that has been dormant and send out threats to sue based on the theory that after several years the debtors financial situation has improved and the person that didn't fear a lawsuit because they had no assets, might have reason to fear one now.

 

The statute of limitations for suing on a debt passed to collections varies by state  http://credit.about.com/od/statuteoflimitations/a/entirestatesol.htm  and it varies widely based on type of debt. Some states allow debt collectors up to 15 years so you can be sitting there thinking everything is fine and suddenly have a lawsuit on your hands. 

 

So while it is certainly possible that medical collections or any other collection might go away if you ignore it, it also might come back to bite you in the ass at a very inconvenient time. Your best option is to work with the internal collectors. Your best bet there is to always be polite and honest. Don't dodge them or play games. If you tell them you will pay more next month, pay more next month, if you don't think you can, don't promise it.

 

Being a collector is a very tough job mentally, they get sick of the bullshit. Call them by their name and be friendly, they deal with people being jerks to them all day long, a little sugar can go a long way. In most cases a collector is likely to give you a break if they believe you are sincerely trying to pay back the bill. Of course, you can always get a collector who is simply an asshole and is going to push you as hard as is legal or in some cases, even go over that line. The person you are talking to on the phone is the one who has the power to either give you more time or kick the can to the next level. 

I just usually go with my own taste. If I like something, and it happens to be against the law, well, then I might have a problem.- Hunter S. Thompson

Beyond Saving's picture

Tapey wrote:All solid

Tapey wrote:

All solid advice. Though I would imagine better advice is to avoid getting into debt in the first place. For me there are only two things for which I would whilingly put myself in debt for. Firstly land, I can see myself buying property with debt. Secondly a car, but only if public transportation is not avaliable (or way to expensive that a car becomes cheaper than it), not when public transportation is inconvienent but just not an option. If you are finding yourself geting into debt with everyday living expenses because something breaks you should be cutting your expenses. Recently I had my car and my computer break in the same month, but because I had been responsible with my money I was able to pay the R9000 ($1100) without having to borrow a cent and I didn't have to wait to have them fixed.

 

However what I am thinking about doing is buying some furnature or whatever I need with debt and pay it off even if I could just buy it so I can establish a credit record with the bank. So when the time comes for me to buy some property they at least have my name on file. But I don't know how worth it that is.

 

 +1000

Unfortunately, few Americans know what living debt free is unless they have already had 10's of thousands in credit debt they dug out of. Living in debt is practically part of our culture. 

 

If you are planning on taking out a loan for land, establishing some good credit history is worthwhile. It will make it much easier to get approved and you will get a better interest rate. 

I just usually go with my own taste. If I like something, and it happens to be against the law, well, then I might have a problem.- Hunter S. Thompson