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Dorothy Rosen -- The Dollar Diva Money Makeover

They forgot what mama said: Save

Sam and Louise Locke are hard-working young professionals who have been married for three years. They have packed a lot of living into that short time; moving to a new city, buying a new home and becoming the proud parents of an 18-month-old son. They've also packed on a lot of liabilities: a mortgage, car payment and $44,700 in student loans and other debt. Their savings account balance is a paltry $400.

The problem started five years ago when Sam graduated from college, saddled with a $15,000 student loan. He had a good job lined up, and his mother offered this advice: Use your earnings to pay off the loan, don't take on any new debt and start saving for the future. "I wish I had listened," he laments. "Instead, I frittered away my cash, used plastic to buy furniture, clothes and whatever else I thought I needed and got deeper and deeper in debt." He didn't start saving for the future, either.

Enter Louise. She made Sam's life complete and added a $22,000 student loan to the debt portfolio soon after they tied the knot.

Time marched on, and the debt continued to mount: doctor bills when they had no health insurance; endless car repairs on an old beater; a loan from his 403(b) plan to buy the house; furniture and other stuff they couldn't afford but bought anyway.

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It costs $900 a month for the Lockes to service the student loans and other debt; add the $940 mortgage, $400 car payment and $570 for day care, and there's just not enough left over to support the lifestyle they've become accustomed to.

"Louise and I are not good at saving," reports Sam. "We are asking the Diva for help in creating and sticking to a budget." It's a good thing repetition is an effective learning tool, because the Diva is going to sound a lot like his mama did five years ago.

Expense chart

Tracking the expenses
In spite of making minimum payments on their debts, Sam and Louise spend more than they earn. They need to trim expenses, and the Diva suggest the following cuts to get the ball rolling:

  • Utilities ($10): Practice conservation
  • Barber/beauty parlor ($10): Stretch out appointments
  • Dining out ($50): Fewer or cheaper restaurant meals
  • Gifts/holidays ($20): Small gifts, large love notes
  • ATM withdrawals ($150): Stop frittering away cash on nonessentials

The $240 saved from belt-tightening will end the $50 deficit spending, add $150 to the debt payments and provide $40 a month for savings.

Managing their money
Sam and Louise need to take time each month to examine what comes in, what goes out, and how they can make it better; they also need to calculate their net worth on a monthly basis. They are currently upside down in both categories; they spend $50 a month more than they earn, and they owe $31,000 more than they own.

The Diva recommends buying a software program to help the Lockes keep track of their money; Quicken and Money are popular choices.

Thomas J. Stanley and William D. Danko, the authors of The Millionaire Next Door, tell us that wealth builders have the following traits in common:

  • "They live well below their means." Frugality is the cornerstone of wealth building; how else would you have money left over for saving and investing?
  • "They allocate their time, energy and money efficiently, in ways conducive to building wealth." They set financial goals; make budgets and stick to them and stay out of debt. Paying interest is not conducive to building wealth.

You'll have to read the book to learn about the other five traits that wealth builders share.

Managing their budget
Dollars allocated for vacations, gifts, holidays, savings and anything else that is not an ordinary monthly expense, must be removed as soon as the electronic paychecks hit the checking account; otherwise, it's too easy to fritter the cash away with ATM withdrawals.

Read the Diva's "Where to open an emergency-fund account," for ideas on where to stash the cash.

"Payment Push" strategy
The $32,000 in student loans is the big monkey on the Lockes' back. If they continue to make the same payments, they'll be hauling this beast around until their toddler hits his teens and they celebrate their 41st birthdays. Even if they stop borrowing now, their student loans and other debt will cost them $17,000 in interest over the next 12 years.

If they continue to borrow as cavalierly as they have in the past:

  • They will never get out of debt.
  • They will pay tens of thousands of dollars in interest.
  • They will probably find themselves in serious financial trouble, especially if one of them is out of work for a couple of months.

The Diva's "Payment Push" strategy calls for spending less and bringing in more. Belt-tightening will make their debt history in four years and two months, and cut their interest bite to $7,000. If they can cut their expenses even more, and bring in additional cash, they could be popping champagne a lot sooner.

Here's how the "Payment Push" strategy works:

1. Program yourself for success: A daily affirmation helps; post this on your bathroom mirror: "By living frugally, we will have the cash necessary to pay off our debts by April 2006 instead of 2014. The $10,000 we save in interest will be put in savings, so we will not have to borrow for emergencies in the future."

2. Prepare a Debt Repayment Schedule. Include columns for the name of the debt, balance due, interest rate, current payment and "Payment Push" period. Rank the debts by interest rate, with the highest one on top. Add a line under each debt to describe how you're going to fund the "Payment Push."

3. The "Payment Push" gets applied to one debt at a time: Continue to make the same monthly payments on all debts except the one getting the "Payment Push."

4. Apply the "Payment Push" strategy to the debt on the top of the list: All extra, available cash is used to pay down the debt with the highest interest rate, first. That includes raises, bonuses, gifts, belt-tightening and pennies from heaven.

5. Hammer away at the rest of them. When the first debt is paid off, use the cash that is freed up to pay down the next debt on the list. Be on the lookout for new ways to cut costs and bring in more money. The sooner a debt gets paid off, the sooner you can hammer away at the next one on the list.

Don't listen to pro-debt talk
The Diva knows all about the tax deduction you get on student loan interest. It's nice, but not nice enough to stretch the loans out for 12 years, and pay more than $13,000 in interest.

Every hard-earned dollar you use to pay off debt is taxed as follows:

  • FICA: 7.65 percent
  • Federal income tax: marginal rate for most folks is 27 percent. It can be as low as 10 percent and as high a 38.6 percent.
  • State income tax: ranges from nothing to 12 percent, depending on where you live and how much you make.

Taxpayers in the 27-percent federal tax bracket, with a 4-percent state income tax, need to earn $138.65 for every $100 they pay in interest.

Clean up the debt, and you'll only have to earn $107.65 to invest that $100 in a tax-deferred 401(k) plan. Better yet, instead of spending your hard-earned money on interest payments, you'll be accumulating wealth for the future. Doesn't that sound like a smarter alternative?

Go to Bankrate.com's "State taxes roundup" for income tax rates in your state.

No more debt
Debt has given the Lockes a nice home, furniture, clothes, credentials and whatever else they wanted to make their lives comfortable. Borrowing is easy; paying back the loans is a bear.

From now on, debt is not an option; this is not negotiable. They must stay on a cash basis, even if it means eating bread and soup seven days a week.

Conclusion
When Sam first got his driver's license, he had visions of cruising around town in his own set of wheels. He was living with his mother back then, and she told him that hard work and saving would make it happen. He listened, and mama's good advice put him in the driver's seat without the burden of monthly car payments. He remembers how sweet it was, and wants that good feeling again.

Sam got off track when he went out on his own and started spending without thinking. "I'm here because I got my wants confused with my needs, and spent money I didn't have to buy things I didn't need," he confesses. He's ready to chuck this behavior and become a fiscally-responsible adult.

Luckily, his wife Louise is eager to join the crusade. Young couples working together have been known to move mountains; the Lockes' commitment is so strong, they should have no trouble moving theirs.

Success is a journey, not a destination. The Diva wishes Sam and Louise the best of luck on the road to financial freedom. The Money Makeover is a weekly feature of Bankrate.com in which money experts help readers untangle their finances. Do you need to get your financial house in order? Could you benefit from the guidance of a customized financial plan? If so, click here to enter the Money Makeover contest! To read more makeovers about people just like you, click here.

-- Posted: Feb. 8, 2002

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