By Kenneth J. Burke, CPA
How did we get here? This is a common question asked by single and married individuals during financial planning meetings. The real question is, “How did we accumulate so much debt?” The answer is really quite simple: regular and disciplined overspending.
Gone are the days of paying cash for any significant purchase. The idea of saving money to fund a major acquisition is unheard of. In the good old days, there was an understanding of personal financial limitation and affordability. The credit culture we now live in is a new phenomenon and has provided a means to purchase anything on credit.
The truth is that we are overweight and out of shape financially in this modern day but nobody knows. We look like we are financially successful on the outside, but the truth is we own nothing and owe on everything. If someone is physically overweight it is obvious to everyone around them. In contrast, the over spender has all the trappings of success like new cars, club memberships and large homes, but the irony is that in many cases they don’t own any of them.
This is nothing new. Just open any financial publication and there are many articles on debt reduction, budgeting, savings and over-spending. There is great advice and information available for those that want to get in good financial shape.
So, how do you start?
- Prepare a Net Worth Statement-It’s time to confront the brutal facts about your financial condition. You may be financially fat. This statement details the assets you own and the loans, mortgages and other liabilities you owe at a particular point in time.
- Prepare a Budget-You knew I was going to say that. But yes, prepare a budget and get a handle on where the money is going. The $5 cup of coffee per day over a 40 year working life totals up to $260,000. If that same $5 per day or $100 per month were invested at 10% over a 40 year working life it would total $632,000. I hope you like the coffee!
- Stop using credit cards and pay cash for items. It is widely held that credit card purchasers spend 12% to 18% more than people using cash.
- List out your debt in order of amount starting with the lowest balance first. This schedule should show the balance owed, the monthly payment and the number of months it will take to pay off the loan. Start paying off the lowest balance debt first. Once that debt is paid, add that monthly payment to the next debt on your schedule and continue the process until all your debts are paid with the exception of your mortgage. The schedule should look like this:
|
|
Outstanding Balance |
Monthly Payment |
# Months to Pay off |
|
Credit Card 1 |
250 |
100 |
2.5 |
|
Credit Card 2 |
500 |
150 |
3.3 |
|
Car Loan |
15,000 |
450 |
33 |
|
Mortgage |
125,000 |
874 |
143.0 |
|
Totals |
140,750 |
1,574 |
|
By the time Credit Card 1 and 2 are paid off you are paying $700 per month on your car payment. You will notice that I didn’t prioritize the debts by interest rate, and that was intentional and not because I’m not good at math. Let’s face it, if we were all so good at math we wouldn’t be in this situation. The reason for this approach is to have quick success by paying off balances and moving quickly to the next one.
- Find ways to save on expenditures and apply that cash to Step 4. You can consider any number of ideas but there are no quick fixes here-just do it. This will accelerate the process and within a short period of time major debt reduction may be achieved.
There have been many books authored on this very topic and all the strategies work provided they are implemented. Programs such as Quicken have debt reduction planners that follow a systematic approach and make the implementation process very easy. The most important thing to do is take action and begin the process of improving your financial fitness immediately.
Kenneth J. Burke, a certified public accountant, is a partner with Mengel, Metzger, Barr & Co. LLP. He may be contacted at Kburke@mmb-co.com.
Reprinted with permission of The Daily Record 2007
