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Money Makeover: Mall mania becomes debt nightmare
Jo Ann Hudson loves to shop. She works eight hours,
sleeps eight hours and spends most of the rest of her time at the
mall. "I mostly shop for anything that will enhance my appearance:
clothes, shoes, makeup, jewelry, purses, hair appointments."
The last thing Jo Ann needs is appearance enhancement: She's young,
thin, healthy and beautiful.
Jo Ann has racked up a whopping $22,480 in unsecured
debt and owes another $13,570 for her gas-guzzling SUV. Debt has
become a way of life for her. She borrowed more than $6,000 from
her parents to pay off student loans and other debts and recently
hit rock bottom when she borrowed $800 from a co-worker to pay an
American Express bill.
Jo Ann is bending under the pressure of the debt and
has reached out to the Diva for help: "I make $40,000 a year
and haven't been able to save a dime. If something were to happen
to my car, if I lost my job or had a sudden major medical expense,
I don't know what I would do. Help! I am only 25 and cannot figure
out how to get my finances under control."
The Diva responds to Jo Ann's cry for help.
Tracking expenses and understanding
the underlying problem
Jo Ann's net pay is $2,200 a month. Almost half of it goes to paying
off debt; she spends $640 to service her unsecured debt and $360
for her car loan. This debt load has her spending $490 more each
month than she brings in.
As soon as Jo Ann saw how serious the deficit spending
was she decided to cut expenses to the barest of bare bones. Jo
Ann's credit rating is good, and she wants to keep it that way.
Here are the cuts that will get her out of the red:
Clothes ($200): Jo Ann has more clothes, shoes and accessories than
she needs.
Gifts ($60): She will use her arts and crafts skills to make personal
gifts for friends and family.
Beauty salon ($50): Skip the beauty parlor until the debts are paid
off.
Dining out ($30): Brown bag lunches until the debts are paid off.
Movies ($20): Library and other free activities will replace movies.
Vacations ($130): The trip to Peru earlier this year added $1,400
to the debt. No more fancy vacations until the debts are paid off.
Jo Ann says, "I want to get my finances under
control and understand why I need to spend more than I have."
The Money Makeover will help Jo Ann get her finances under control
but helping her understand the negative behavior pattern is outside
the Diva's area of practice. Luckily, the momentum for change is
there, and Jo Ann is finding help in all the right places.
Jo Ann's mother and boyfriend suspected that her overspending
might be compulsive behavior and urged her to attend a Debtors
Anonymous meeting. This happened during the course of the Makeover.
"I've gone to a couple of meetings and so far I really like
it," she tells the Diva. "I'll let you know more after
I've been going for awhile." Debtors Anonymous is a 12-step
program fashioned after Alcoholics Anonymous. It encourages and
supports abstinence from unsecured debt -- one day at a time.
The Diva's "payment push"
strategy
Jo Ann's belt-tightening puts her in a break-even position, but
it doesn't free up extra cash for debt payments. Once again, her
parents are offering a helping hand. She pays them $200 a month
on their $6,020 interest-free loan; they're going to let her defer
payments on this loan until her high-interest credit card debts
are paid off.
If she continues to make minimum payments on her $15,660
credit card debt, Jo Ann will still be making payments 30 years
from now and she will lay out $27,000 in interest payments. The
extra $200 each month coupled with the Diva's "payment push"
strategy will have the credit card debt paid off in three years
and five months.
Here's how the "payment push" strategy will
work for Jo Ann:
- She will make a schedule
of the debts including: (1) debt name, (2) balance due, (3)
interest rate, (4) time period for the "payment push"
and (5) how to fund the "payment push."
- She will place her co-worker's $800 no-interest
loan on top of the list. This type of loan is odious to both the
lender and the borrower and must be eradicated swiftly. The extra
$200 from deferring the payments to her parents will clean this
up in three months.
- The remaining debt gets ranked by interest rate,
putting the 23 percent Citibank debt on the top and the parents'
no-interest loan on the bottom. She should express her gratitude
to her parents for this generous gesture at least once a month.
- The same monthly payments are made on all of the
other debts.
- As soon as the co-worker's loan is paid off, the
$100 freed up from the original loan payment plus the $200 freed
up from the parents' loan is used to pay down the debt with the
highest interest rate (Citibank).
- Once the debt with the highest interest rate is
paid off, the cash that is freed up is used to pay down the debt
with the next highest interest rate. And so it goes until all
the balances read zero.
- Raises, bonuses, tax refunds and all cash windfalls
get added to the "payment push" pot so the debts are
paid off ASAP.
By following the Diva's "payment push" strategy,
all of Jo Ann's debt, including her car loan, will be paid off before
she's 30, giving her an extra $1,000 in cash to manage each month.
Managing her excess cash
Jo Ann needs to plan for that happy day when she's debt free. Here
are some suggestions for managing the extra $1,000 in disposable
income she's going to have each month:
- Make life more fun ($200)
- Build an emergency fund ($600)
- Add to her 401(k) plan ($100)
- Save up for things on her "wish list,"
such as a leather jacket and laser surgery ($100)
Saving $600 a month will create a $7,200 emergency
fund in a year. After that, the $600 can be used to make maximum
contributions to Jo Ann's 401(k) plan and allow her to save for
long-term goals like an exotic vacation, the down payment on a home
and accumulating enough wealth to be financially independent.
Conclusion
Jo Ann is determined to turn her fortunes around. She has looked
her debt in the eye, knows how it got there and what she has to
do to get rid of it. Jo Ann is a very smart, motivated 25-year-old
woman; she has embraced the concept of abstinence from debt, one
day at a time, and the Diva thinks she's going to succeed.
-- Posted: Aug. 10, 2001
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