Email question: Young and in a debt-rut, how do I get out?

Good afternoon!  I have really enjoyed reading your blog and following you.  I know there are other people out there like me, but I haven’t really found the resources I am looking for.

Basically I am drowning in debt.  I don’t know where to start.

I am in my early 30’s and have a job that pays $85K/year.  In the past few years, but more notably this last year I have gone on a significant spending spree and essentially eliminated my entire savings.  I realize that this is a self-esteem induced thing and I am currently working on that issue as money allows.  

So I’ll give you my stats about my nightmare:

32.  Making 85/yr.  I’ve been at the job just about a year.

Rent: 1500 month – I did not renew my lease so I will be moving to a MUCH smaller place for a little over 1000/month.  

My credit score is 708.  

I ran a report recently and my debt breaks down as follows:

Credit Used – 66%

I have approx. 20K in credit card debt. This is spread out over 6 cards.  All of them maxed out.  I have other credit lines but they are store-specific and have no need to use them.

I also owe I little over 27K on my car which is about 10K in the negative according to kelley blue book.  Fortunately I have a hybrid and live close to work so I do not rack up much in the way of gas bills.  

I owe about $600 in medical bills.

I’ve started to take a small second job but it will barely offset anything.  

I have been good at paying over the minimum, but have to withdrawal from that regularly to cover expenses.

I got rid of cable, and I am getting ready to sell much of my furniture and things to put directly into my credit cards. 

I have had most of these cards for several years and they carry an APR of over 20%.  

I looked into the nfcc.org to help figure out this mess.  My parents are both retired and on a fixed income so I am unable to get help from them.  My gut is that this isn’t insurmountable, but I am having a difficult time coming up with a plan to get out of this rut.  

Thank you for all of your help.  

J.

Wow, that’s a lot J.

Let’s start with your credit score. You are obviously struggling, but guess what doesn’t reflect this? Your credit score. A 708 credit score doesn’t accurately depict your financial situation. This is why I don’t like credit scores as a measure of financial health. Your net worth (assets minus liabilities) is a much better indicator of your financial health.

You didn’t mention your net pay, but from what information you did give I’d assume you are bringing home $4,500 a month. Which means your previous rent of $1,500 was about 34% of your take home pay. This is WAY TOO MUCH. I recommend spending no more than 25% of your take-home pay on rent, which your new rent fits. So great job for making this move! Not only will this put you in range for the recommended housing budget, but you’ll now be saving $500 a month.

Being 10k upside down on a car is a bad situation, but sadly not an uncommon one. Probably what happened is you financed negative equity on a previous vehicle into your current lease. My advice? Drive the wheels off your current vehicle. You and this car are in it for the long haul.

Those are just of few first observations, but the main point I want to make relates to your comment- “I have been good at paying over the minimum”. This is a big issue. We have all been taught that minimum payments are evil. And that paying over the minimum means you will pay off your debt faster. Unfortunately, this isn’t true at all. Throwing money at all your debts just keeps you spinning in place. You need to follow what I call the Momentum Method. Let’s for a minute imagine you are struggling with losing weight. Your goal is to lose 60 lb. Except any one who has ever dieted will tell you having a goal of 60 lb. is overwhelming. You will fail before you even start. Your overall goal may be to lose 60 lb. but you need to start much smaller than that. Maybe it’s 5 lb. this week. You need to do the same thing with your financial situation. Your overall goal is to pay off debt, but your first short-term goal is to pay off the bill with the lowest balance.

So here’s your plan. List out every debt you have. Then instead of arranging them by interest rate or monthly payment, arrange them by balance. Ignore everything else. Your goal is to pay off the lowest balance debt first while still paying the minimum on everything else. So the money you were previously throwing at all your debts will now be concentrated on one debt. Since you just decreased your rent by $500 this should help you knock out at least one debt. This is going to create positive momentum for you.

A thought on second jobs: Good for you for picking up extra income, but be careful to not throw it into your main budget. This income, penny for penny, needs to go directly to debt pay down. The $200 or whatever you are bringing in extra per month means you have $200 extra a month to pay on debt. I see this situation a lot where people put out the extra effort to get a second job but then just absorb the new income. This isn’t smart.

Just like eating healthy and exercising, you need to develop smart financial habits. It will take time and discipline but it’s the only way to get out of the debt rut you are in.

Also, not to get sales-pitchy but my 60 Minutes to Change 12 page guidebook is a great way to work through your financial life. Plus it’s only $3.99.

I also answered your question this week on The Pete the Planner Radio Show on WIBC.

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