Author: wizardpc

Last week I covered the Debt Snowball and mentioned that you needed to have a budget, so this week I’ll cover how to do that.

Bah! Why are you covering this? I know how to do a budget!

Really? Off the top of your head, what’s your monthly budget for clothing? Groceries? What’s your budget for gas? Not, “Oh, I usually spend about…”–that’s not a budget.

A budget is where you declare “I have $300 to spend on gas this month, and I will not spend any more than that.”

What we do, and what Dave Ramsey teaches, is called a zero based budget. Basically what that means is we know where every single dollar we make is going to go before we get paid. So you “spend” your entire paycheck the day you get it. Using this method, if you go over budget in one category, you have to take that money from another category because by now you’ve stopped using credit cards.

So if you had $300 budgeted for gas, but with 5 days left in the month you have 1/8 of a tank, you’ve got to take money from somewhere else. Perhaps clothing or “blow money.” And next month, plan better :D.

Here are the basic categories I used when I was single and doing this plan all by myself:

• Groceries
• Fuel
• Bills
• Rent
• Utilities
• Insurance
• Cell Phone
• Blow money
• Debt Reduction
• Visa
• Mastercard
• Car Payment
• Student Loans

That’s a pretty simple list. It is a good starting point, but if you want something a little more detailed, check out this budget form from Dave Ramsey.

A note about Blow Money: This is your walking around money. This is where you pay for renting movies, going out to dinner, and hitting the range. I discovered that I could get by with $60 a week in blow money and that has been my amount for several years. My wife gets the same amount even though she doesn’t make as much as I do. (That suppressor I bought recently was bought with blow money I had been saving since January)

A major component to the budget is the envelope system. What that means is that for certain categories you take cash out of the bank and put it in envelopes. When I started, I used cash for groceries, fuel, and blow money. Pretty quickly I learned that paying cash for fuel totally sucks so I stopped doing that. Now I use a debit card at the pump.

I did kind of a weird thing with regards to bills. I opened a second checking account and paid all my bills using that account. I signed up for auto-payment wherever possible and used online bill pay. The only check I had to write was to my landlady. I knew how much my monthly bills were going to be so I divided that by two and deposited that amount into the bills account every payday. It worked out really well for me and we still use that system today.

So this is how it looks on payday. Let’s say you get paid twice a month, and your paycheck is $1670 (speaking of which, you have stopped your retirement contributions, right? That’s not until step 4). Here is what it looks like:

• Go to the ATM. Take out $100 in cash for groceries and $120 in cash for blow money.
• Transfer $800 to the bills account
• Apply $500 to The Debt Snowball

You now have $120 in your pocket and $150 in your primary checking account for fuel. In an envelope you have $100 to buy the next two weeks’ worth of groceries. The rest of your paycheck has been spent.

Now, I don’t know what your situation looks like, but this is the basic idea. To get your numbers, go through your bank and credit card statements for the last six months and see where you spend your money. You might be surprised, as I was, at where all your money has gone!

When I did this, I discovered that while I thought I was spending $80 a week on groceries, I was actually spending almost $300 a week–because while at the grocery store (which was Wal-Mart because that’s your choice when you live in Mississippi) I was picking up things like DVDs and the occasional digital camera. The other thing that really surprised me was how much less I spent if I used cash. There’s something psychological about it.

Last week I covered Baby Step 1: The $1000 Emergency Fund. That step can usually be completed in a month or so, depending on your situation. From there, you move on to what really is the core of “the plan”–The Debt Snowball.

In the debt snowball, you take all of your debts and list them smallest balance to largest balance. ALL OF THEM. This includes the twenty bucks you borrowed from your fishing buddy. It includes the $75 you owe your dentist for the cleaning two months ago. It includes your cars, motorcycles, and boats. Store cards, credit cards, and loans from parents. Everything.

Interest rates only matter as a tiebreaker. The reason you do it this way is entirely psychological: reducing the number of creditors is a better positive reinforcement than reducing your total debt. If you pay off $1000 of debt and get rid of two store cards you feel like you’ve made a whole lot more progress than if you pay off $1000 on an account and you still owe $7500. Going from 7 creditors to 5 within the first month is an awesome feeling.

Okay, so how does this work? Well, you take your ordered list of debts and you pay minimum payments on all of them. Except the smallest one. That little bugger? You’re trying to murder him. Kill him with fire! Any extra money you have in the budget (you do have a budget, don’t you?) goes to kill him. Every bit of overtime goes on that guy. If you sold an extra rifle you put that money on the smallest debt (Later, you can buy a new one. I hear they keep making them).

When that guy is dead, you move up the chain. Only this one will go a bit faster, because you don’t have that first debt’s monthly payment anymore. So if you had a Visa with a $25 minimum payment as your first debt, and a Discover with a $45 minimum, your new absolute lowest payment you’ll make on the discover is $70. Make sense?

By the time you get to the last debt, you could very well be paying thousands of dollars every month on it without having changed your lifestyle very much since the beginning. When I was single, I paid about $1600/month on my student loans at the end, which was about half my take home pay. I think the number was close to $3500 at the end of my wife’s snowball.

This step will take 18-24 months on average. I did it in 30 months when I was single and we paid off my wife’s debts 28 months after we got married (our debts were roughly equivalent and for the same things).