Financial Literacy - How to Prosper
Couple wants to conquer credit card debt

The plan

Both are in stable jobs, love what they do and envision being in their careers for a long time. To achieve their goals and prosper financially will take time and discipline.

Develop a budget

Their financial journey begins with budgeting. They need to immediately tighten the belt on discretionary expenses in order to maximize their debt repayment efforts and accumulate funds for their wedding and honeymoon. Cutting spending by a total of $500 per month is of critical importance. Even little things like utilizing flexible spending accounts for medical, dental, prescription and co-pay expenses will generate savings because these expenses are paid with pre-tax dollars. Amy and John can easily measure their progress over time by watching their credit card balances decline and savings account balances increase.

The hard part will be employing the effort and discipline to trim discretionary expenses so they can live on only their base incomes. This is necessary so the additional, fluctuating income they each receive -- Amy from coaching, John from working overtime -- can be devoted entirely to paying down the credit card balances.

Find money for wedding

Because Amy and John are paid every two weeks, there are two months per year in which they receive three paychecks. Those third paychecks, slated for January and July in 2010, are more than sufficient to fund their expected wedding/honeymoon expenses and still jump-start an emergency savings cushion.

Get rid of debt

When Amy's CD matures in February, she should put $500 of the proceeds into her savings account and apply the remainder to her credit card debt. John can terminate his whole life policy, take the cash value and do the same thing: put $500 into savings and the remainder toward credit card debt. This will give them some immediate headway toward getting the debt paid off.

With money from the maturing CD, her income from coaching, and the extra funds that will materialize when one of her student loans is paid off in mid-2011, Amy is in a position to have her credit card debt completely erased in two years.

Once Amy's debt is retired, she can begin making retirement contributions and boosting emergency savings while John pays his debt off.

For John, it will take a bit longer, but he can pay off all credit card balances in three to four years. He can do this by trimming monthly expenses, earmarking all overtime income and most of the cash value of the terminated insurance policy toward his credit card balances.

If they follow through by adhering to this disciplined program of cutting expenses and maximizing debt repayment, the next few years can make a lifetime of difference for Amy and John. Fast forwarding four years, they could be credit-card-debt free, regularly contributing to emergency and retirement savings and closer to reaching the goal of one day buying a home -- all by age 30.

From there, they will be in a position to prosper.

The plan in 4 steps
1) Cut expenses and adhere to strict budget.
  • Understand trade-offs between spending and saving.
  • Realign priorities to match financial goals.
  • Cut $500 of discretionary expenses per month.
Tip: Get started by tracking expenses with this spending plan work sheet.
2) Accelerate debt repayment with additional income.
  • Allocate income from part-time jobs toward debt paydown.
  • Apply all but $500 of CD at maturity toward Amy's debt.
  • Apply $500 cash value of terminated life policy toward John's debt.
Tip: Use Bankrate's Debt pay down calculator.
3) Allocate "surplus" paychecks toward wedding/honeymoon.
  • Two months a year, biweekly paycheck recipients get three paychecks.
  • In 2010, this occurs in January and July.
  • Use them toward wedding expenses this year.
Tip: Read Bankrate's story on 5 ways to cut wedding costs.
4) Once debt is paid, turn attention to savings goals.
  • Start habit of consistent saving for emergencies.
  • Begin salary deferrals into 457 plans.
  • Allocate funds toward down payment on a house.
  • Learn from experience and don't fall back into debt trap.
Tip: Use Bankrate's emergency fund work sheet.

This report was prepared by Bankrate Senior Financial Analyst Greg McBride, CFA.

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