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DIY Debt Reset

March 8, 2021

The DIY (do-it-yourself) debt reset is where you sit down and develop a hardcore strategy for getting out of debt without a formal insolvency proceeding.

Start by gathering up all your bills, credit card statements, and pay stubs.

Review your income:

Calculate how much money you have to play with.  If you are paid every two weeks you will have two months each year when you get an extra pay, if you are paid every week you will have four months each year when get an extra pay.

Since most months you do not have the benefit of that extra money it is best to treat as if it is never there rather than to count on it.  It can be set aside when you do get it in order to cover shortfalls than may come up from time to time.

Check your household expenses:

Take the time to thoroughly review your monthly household expenses.  Be thorough, very thorough – did I mention you must be thorough?  Here is the thing, after over 25 years of going through household budgets with thousands of people, it is clear that most people do not know how much they spend or where they spend it.  Sure, you know how much your mortgage or rent is even your other “fixed” expenses but where you are most likely to get lost is in variable and irregular expenses.

Fixed expense:  A fixed expense is when you pay the same amount every month, equal billing on utility accounts for example.  It is easy to set up fixed expense payments to come out of a bank account at the same time each month.  Mortgage rent and utilities along with car loan and some other debt payments are frequently set up this way.  This can be both a good and bad way of paying bills, as long as you have regular cash flow and sufficient funds available, automatic payments are very helpful.  However, if you are going through a spell of unemployment or reduced income, having automatic withdrawals can be bad because they can lead to unexpected NSF charges and that can quickly spiral out of control.

Variable expense:  A variable expense would be something like gasoline for your vehicle, groceries, entertainment, eating out, etc.  Variable expenses need a little more attention than fixed expenses because they vary it can be difficult to get a handle on how much we are actually paying.  When I ask clients “how much do you spend on groceries?” they often think back to their last major shopping trip and respond with something like “Well last Saturday we spent $100 so probably $400 per month.  But do not forget about picking up grocery items during the week, milk, bread, coffee, etc., as well as periodical household supplies, cleaning products and so on.

Irregular expense:  irregular expenses are things like Christmas or Birthday gifts, car repairs, clothing and other expenses that are do not occur every month.  These can be the toughest budget busters, for example many families overspend at Christmas on gifts, parties, donations, and lavish meals.  But we do not prepare our finances for these expenses, we treat them as if they came out of the blue.  If you spend $1,000 per year on Christmas stuff that breaks down to about $80 per month that should be set aside, not “saved” but “set aside” it is similar but quite different.

Balance your budget:

Your budget is in balance as long as you do not have more money going out each month than you have coming in, it is that simple.  The idea is not to spend everything coming in but rather to account for it.

Debt Payments:

Debt payments are insidious, they creep upwards very easily, too often people look at what they can afford to pay rather than what the total cost of using credit is.  Since I started my insolvency career, minimum monthly payments on credit cards have gone down.  In fact, minimum monthly payments have gone down to the point that making only the minimum monthly payment reduces to principal amount of the debt by such a minuscule amount that the debt goes on into perpetuity.

Whatever the required payment on a credit card, the debtor should be paying at least 3-4 times more than that in order to repay the debt during this lifetime.  Unfortunately, the government will not regulate the banks and the banks will not regulate themselves to help the consumer.

When you are thinking about affordability, look beyond minimum monthly payments, pay more attention to total cost including interest.  But if you have read this far into this blog that information is like closing the gate after the horse has bolted.  Getting out of debt is going to require concentration and effort.  Go back to your budget and look for expenses you ‘could” live without.  Start eliminating expenses that are unhealthy, drinking, smoking and drugs, legal or not, these are expenses that do contribute positively to your life.

Then work your way through frivolous expenditures like eating out and entertainment, gifts for others – try making gifts or doing something for someone else instead of spending money on them.  Most people think of “eating out” as being going out for diner, but that category includes grabbing a coffee at Tim Hortons.  When you think about it a coffee per day at $1.85 is $675.25 per year (after taxes) or about $1,000.00 of pre-tax income add in a muffin at $1.59 per day and the bill jumps to nearly $1,700.00 per year, pre-tax income.  In other words, 4% of your gross income is going to Tim Hortons each year.  That may not sound too bad, but when you add in lunches, pizzas and other takeaway food items that cost can easily jump to 10-20% of your gross (pre-tax) annual income.

Alcohol is another huge expense for Canadians who spend between $100.00 to $1,000.00 per month on recreation use of legal substances.  Worthy of note is that the government deemed the sale of these substances as “essential” during their lockdowns.   Although the median spend is about $500.00 per month a more realist, mean, value would be about $200.00 or $2,400.00 per year (at least $3,000.00 in pre-tax, gross, income).  Just by cutting out recreational substance use and eating out you will free up close to 11% of your annual income to manage paying down your debts.

Homeowners:-

Homeowners are often tempted to consolidate unsecured debts, credit cards, loans, and lines of credit into their mortgages.  Sometimes, even car loans are consolidated in order to reduce monthly expenses.   This can be a good or a bad thing depending on how the property is leveraged, why it is being leveraged and what you are going to do afterwards.  Remember, and this is really important, you do not own your own home until after you have made the last mortgage payment – in effect, you are simply renting from the bank.  If interest rates go up, so does your rental cost. 

Imagine, if you will, you have a credit card with a $20,000.00 balance outstanding and you decide to consolidate the debt into a 25-year mortgage with a low rate of 2.5% – after 5 years, interest rates rebound to closer to a historic average of 5%.  After you have finally made your last payment, you will have paid nearly $12,000.00 in interest.  By contrast if you closely monitor your own spending and pay the whole balance off within five years you will have paid about $10,500.00 in interest charges.

Savings versus Setting Money Aside:

There is a great difference between setting money aside and saving money.  If you are saving money it is for a long-term goal, not an irregular expense.  On the other hand, since you know you will have irregular expenses, money should be set aside to meet those payments.  Back to our example above – if you have annualized Christmas, clothing, and car repair costs of $1,000.00 each you should be setting aside about $250.00 per month, that way, if you have any one of those expenses arise the money (or at least most of it) will be there to pay the costs.  By contrast if you are saving $250.00 per month, your savings should be growing, each month, by your contribution amount.

Getting started with savings is hard for people who have never saved before.  Suppose you are first time savers and decide to go ahead an save $250.00 per month, for many people it might look something like this:  Month 1 you and your spouse put $250.00 away; you are quite proud of yourselves, seemed easy enough.  Month 2 you almost forgot about savings but luckily your spouse did not, and you were able to put another $250.00 away.  Month 3 by the end of the month you find that you do not have enough money to save the $250.00 so you put away $100.00 with a pledge to increase next month’s payment to make up for the shortfall.  Month 4 and your car has an unexpected repair cost that devastates your bank account, you dip into your savings to cover the cost.  Month 5 you and your spouse look at each other hopelessly with only $100.00 left at the end of the month and decide that a pizza/wing combo and a box of beer seems like a better idea than trashing your own ambitions.

To save smart, for first time savers we recommend starting small and growing your savings over a loner term.  For instance, start by saving $25.00 per month, keep that up until you reach a comfort level that will allow you to add another $10.00-$25.00 per month and repeat.  By starting slowly, you will not shock your budget and after a few bi-annual increases in your contribution level you will be happy with the results.

To learn more about budgeting, household finance, debt management and to get your DIY Debt Re-Set started give the office a call at 519-646-2222