Question: Hi there, I am a constant listener of your show. I just wanted to get your opinion on my latest personal finance thoughts. My husband and I have made pretty bad and spontaneous financial decisions that have brought us a lot of debt. Our plan for 2012 is to get out of debt and start saving more, since we depleted our savings in the past 2 years. I would like to know how to start getting rid of this debt in the smartest way and how to save significantly at the same time. Carla, Boston, MA
Answer: Thanks for listening. And congratulations on your financial resolution for 2012.
I always feel a little uncomfortable giving advice on how to get out of debt, mainly because it's easy to say (or type) what steps to take and it's hard to accomplish the goal in reality. I know from personal experience! The good news is that you've taken the first and most important step: the desire to get out from under debt and boost your savings.
Here are some steps to consider. Since getting out of debt is a priority, I would establish a minimum level of savings first. This is the savings you'll use to meet various unexpected expenses, like a new car battery. You'll want enough set aside so you don't have to use the credit card to pay an unexpected bill. This is your first goal.
Once that savings sum is in place, all your financial efforts shift toward reducing debt. You'll want to set up a budget. It's a way to seize control of your finances. Many tricks of the savings trade help with sticking to a budget, such as leaving the credit card at home in the freezer and paying for everyday expenses with cash. (Not all the savings tricks will be appropriate for your temperament and household; embrace the techniques that reflect your lifestyle.)
I don't know if you have one big debt (like a second mortgage) or several debts (on different credit cards) to tackle. If it's the latter, the technique I favor is called a "debt roll-up." It's an approach that picks up momentum over time. The basic idea is to pay the minimum on all of your credit cards except for the one with the highest rate. Target all the extra cash you've found through budgeting and clamping down on your spending toward that high-rate card. Eventually, the debt is paid off. Then you target the next-highest-rate credit card and pay the minimum on everything else. And so on, until the debts are gone.
Of course, if you have just one big debt, all the extra cash you've scrounged up goes toward it.
Another habit I like to encourage for anyone dealing with a difficult issue like getting out of debt is setting up a weekly money meeting. It should be short. It's best to hold it at the same time every week. It's a good way to keep the two of you focused on your financial goal, track your progress and prevent any money problems from festering. The process of eliminating debt is stressful and this is a way of not letting the task come between you. I would also use these meetings to come up with a plan on how you want to manage your money once the debt is gone.
That leads into my final suggestion: Automate your savings once the debt is eliminated. Saving more is now the top financial priority. Well, anyone participating in a retirement savings plan such as a 401(k) has the money automatically taken out of every paycheck. We don't even think of spending it because it's gone before our paycheck reaches our checking account. You can do the same thing with your bank accounts. So, when savings becomes the priority, I would have some sum of money -- no matter how small -- automatically moved from your checking account into your savings account every month.