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
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.
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.
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
- 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
are popular choices.
Thomas J. Stanley and William D. Danko, the authors
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
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
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.
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
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
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-- Posted: Feb. 8, 2002