To get a better sense of how we can gain some fiscal control in our lives and work toward being financially free, let’s look at a hypothetical situation. In the file linked below you’ll find a household bringing in $3,000 per month (after taxes). After monthly variable and fixed expenses are accounted for $0 are left over for savings. In short, they’re living hand to mouth.
To make matters worse, they are paying for the sins of the past. Paying off credit card debt ($15,000 outstanding) is consuming $600 of their income. If that allocation was not present, they would be able to have a monthly savings rate of 20%! We’ll discuss the credit card debt in a moment.
What else do we see? Variable expenses compose a little over 1/3rd of the spending per month. Every situation is different, but if a $100-$200 each month could be cut from the variable expenses, then further resources could be used to help extinguish the credit card debt fire that’s burning.
Fixed expenses listed seem pretty reasonable. A lot of what we see is related to necessities and the ability to totally eliminate items probably isn’t going to be practical. Possibly a reduction of phone and Internet costs could occur. If we look at phone, Internet and cable costs, we’re talking $150 a month. If that was dropped to $100, then we find another $50 to push toward eliminating the credit card debt problem.
As you probably have realized, I’m consumed with killing off the credit card debt item that exists within this scenario. I haven’t talked about retirement savings, other purchases or anything else but paying off the credit card debt. In short, if you have credit card debt, forget all these other personal finances goals for the moment, the road block that’s going to prevent you from reaching them is looking you in the face. Credit card debt is expensive, creates no tax savings like a home mortgage can, and is harming your ability to borrow in the future (credit score).
In our example, the credit card interest rate that is being incurred annually is 18%. In real life, the rate could be even higher. The first principal of gaining financial freedom is to attack that which is inflicting most harm. An 18% borrowing rate and a depleted credit score are both painful. Therefore, the first priority is to push all available free resources to rid yourself of this problem.
The given facts had $600 per month being allocated to the $15,000 credit card balance. Assuming no additional debt was going to occur, the person/family in this example would be free of this problem in a little over 2.5 years. If an additional $200 could be cut from monthly expenses, then at $800 per month the credit card problem would end in 1 year and 10 months. A significant reduction in time.
Though $15,000 is a sizable amount of money, and a 18% rate of interest is high, the ability to cure the problem is not out of the question. The fact that credit card debt exists means that overindulgence occurred in the past. To balance the excess, reductions in the present and short-term future need to occur. Keep this in mind, the average life span of a person in most western countries is around 80 years. A few years of sacrifice is a lot better than decades of piling up debts, a decimated credit rating (ability to borrow in the future), and having to continually live your life for the past rather than the future.
More to follow…Debt settlement negotiation and ideas on where to start saving.