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Updated on Tuesday, March 24, 2015
Last week, the MagnifyMoney team was in Atlanta, Georgia. We regularly take our Debt Free Guide for a spin (you can download it here), helping people build their plans. You can learn from their stories, and take inspiration from their progress.
Last week we helped Diana (her name has been changed, because debt is still a taboo topic in this country. We hope that changes eventually). Here is her situation:
- Fully retired. She receives two monthly pension checks (both from very stable companies) and Social Security. The total net income is $4,000 per month.
- She has a mortgage. Her home is $20k underwater. She has a great interest rate of 3.75%. Her monthly mortgage payment is $1,500.
- She has a car. It is worth $16k. The balance is $10k, and the monthly payment is $600.
- She has $27,000 of credit card debt. She is only making the minimum monthly payments, and the average interest rate is 20%. That makes her monthly payment about $720, of which $450 goes towards interest.
- She has no other debt. But she feels completely broke and worries that bankruptcy will be rapidly approaching.
- She has no cash in the bank, and no emergency fund or savings.
- Diana has a 660 credit score. Although she has a lot of debt, she has never missed a payment. The score dropped below 700 because of the absolute level of debt.
In our Debt Guide, we always follow a 3-Step Process. That is:
- How Bad Is It?
- Establish A Plan
- Future-Proof Yourself
How Bad Is It?
To determine the best plan, we look at three things:
- Do you spend less than you earn each month?
- How much debt do you have relative to your income?
- What is your credit score?
1. Diana is spending more than she earns each month. To figure out the problem, we first looked at her fixed monthly expenses (home + auto) as a percentage of her monthly income. Her fixed costs = $2,100 per month. Her income is $4,000. That means her fixed costs are 53% of her income. Warning: once you are above 50%, it is time to stop and re-assess.
Before moving forward, we need to solve the fixed expense problem. After speaking with Diana, we came up with the following solution:
- Diana has a basement apartment that can be rented out for $600 a month. Although Diana is not looking forward to being a landlord again, she will do it for the next 24 months, and then her peaceful life can return.
- Diana will sell the car. With the $6,000, she will buy a cheap car. It is easy to find a car for $6,000 that will last two years. I referred her to TrueCar to find the right option. That will save $600 per month.
Between these two actions, Diana will save a massive $1,200 per month (although there will be some tax liability on the rental income).
2. Diana’s total credit card debt is $27,000. Her net take-home pay is $48,000 per year, which is about $60 before taxes. Her total debt is 45% of her income. Once that number gets above 50%, it can become almost impossible to get out of debt. If she continued to add to the debt, she would go bankrupt. But we started talking just in time.
3. Diana has a good credit score. If her score was above 700, she would have a ton of options. But, at 660, she still has some very good options available.
Based upon her situation, we had a plan: Transfer & Attack, using a Personal Loan as the weapon.
Establish A Plan
We knew that Diana would have an extra $1,200 a month because of her home and her car.
We made a list of her debt, from the highest interest rate to the lowest. Some of the debt had outrageous interest rates, close to 30%. Some of the debt had very good interest rates, close to 8% from credit unions.
With a score of 660, we used the MagnifyMoney Personal Loan tool to find a way to cut the interest rate on the debt, and take years off repayment. She applied to a number of lenders, and ultimately was approved for a loan of $15,000 from LendingClub*, with an APR of 18%. We were able to pay off all of the debt that had an interest rate higher than 18% with the loan proceeds. The entire process took fewer than 15 minutes. The loan has a 3 year term, and will save her more than $1,000 in interest.
Once the transfer was complete, we agreed her payment plan:
- The first $2,400 from her car and home (two months) would be put in a savings account as an emergency fund. She selected her savings account from our Savings Account marketplace.
- The rest of the savings would be put towards the high APR debt first. She would pay only the minimum due on everything but the highest APR debt. And all extra money from the car and house would go towards that debt.
- In just a little over two years, her debt should be completely paid off.
Future Proofing Her Life
We talked about a few important lessons.
First, you should never borrow what the bank says you can afford. Instead, borrow much less and leave plenty of cash for life. In two years, she can buy a nicer car. But she will never have a car payment that big again. And, if she wants a nicer car, she will wait longer and save for it.
Second, store credit cards are an obscenely expensive temptation. Although traditional advice is to keep credit cards open, we decided to cut up those store cards. And she promised to never use them again.
Finally, Diana was very honest with herself. She has a very hard time dealing with temptation. So, she will be going on a strict cash diet. No credit cards for her! As cards are paid off, she will cut them up. She will only keep one credit card open at the end of the 24 months and will use that for making her cell phone payment – keeping it out of her purse.
Although technically it would be better to keep more cards open, Diana is honest with herself and just doesn’t trust herself with credit. Gamblers shouldn’t move to Vegas, and shopping addicts should’t fill their wallet with credit cards.
She looked visibly relieved at the end of our session. She had a plan. And we will keep in touch with Diana to see how she is doing. Diana was on the brink. If she continued spending, she would have ended up in bankruptcy. We are thrilled that we could help her.
If you would like to have a free 30 minute session with someone from our team, you can schedule an appointment here. We can help you build a plan to be debt free forever. Once you commit yourself, it can happen a lot faster than you imagine.
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