Because most philosophies that frown on reproduction don't survive.

Friday, January 08, 2010

No More Debt, in theory and in practice

A few weeks ago Darwin's favorite economics podcast, EconTalk, featured Megan McArdle, a libertarian blogger he reads frequently. The topic was Debt and Self-Restraint, and a good portion of the podcast was devoted to McArdle discussing how she'd worked out of debt by establishing a budget, using cash instead of credit cards, and paying off loans as fast as possible. Of course these are pretty basic principles, McArdle allowed, but "pretty basic" does not translate into "universally followed". Even we, who consider ourselves basically financially savvy, found ourselves writhing guiltily as we pondered our lack of firm budget and our reliance on credit cards as our normal financial tool.

McArdle had been inspired to financial self-control while researching Dave Ramsey for an article she wrote for The Atlantic. We had never heard of Dave Ramsey, but it seems he's a financial guru with a radio following of 3 million listeners. So we bought Ramsey's latest book The Total Money Makeover (on Amazon, using a credit card), and read and discussed it over the holidays. In the book Ramsey says that people tell him that his book was the first one they'd read in ten years, and (to be honest) it does read rather at that level, but his process in a nutshell is:
1. Quit using credit cards
2. Make a budget in which every last dollar of income is accounted for.
3. Save $1000 as an emergency fund.
4. Start paying down debt (except your mortgage) with every extra dollar, starting with your smallest debt. Pay the minimum on all other debts.
5. As you pay off a debt, roll that money into paying off your next smallest debt.
6. Once your debt is paid, save a larger emergency cushion, perhaps equal to three months income.
7. Pay off your mortgage at an accelerated rate.
8. Invest, Give, and Have Some Fun with your money.
Our debt, we thought, lay in four categories: Student Loans, Mortgage, The Van, and The Dryer. In an act of self-delusion, perhaps, we never considered ourselves in credit card debt because we pay off our card each month. But, as we contemplated moving to an all-cash system, we had to confront what we knew intellectually but hadn't considered practically: that, if you pay your card on the due date each month, you're really two months in arrears. You have the month you're currently spending on, and the previous month for which you have the statement and the bill. This works out fine if you intend to keep paying your statement balance every month, but if (as we have for years) you do all your spending on the card, then when you decide that you want to switch to an all-cash economy you're faced with, well, debt.

So. Today is the first payday of the new year, and it's the day for the switch. We plan to follow Ramsey's basic outline, except that we're not going to pay down the smallest debt (the dryer -- which is at zero interest for another 8 months anyway) first. First, we're going to get out of credit card debt.

UPDATE: (A word from Darwin) The really tough thing, contemplating all this, has been accepting the idea of ceasing to use the credit card, going to an all cash budget, and then paying off the credit card over a series of months as a debt. I don't think I'd realized up until I contemplated this how much of my pride is wrapped up in the words "I don't carry a balance." Sure, at several points in our marriage, after a major expense (giving birth, etc.) we'd carried a credit card balance for a couple months, but in each case we'd budged very aggressively until we were back to paying off the entire credit card every month. I drew a lot of pride and satisfaction from thinking (when I read about how the average household carried 10K+ in credit card debt) "But we don't have a problem, we don't carry over a balance." thus putting ourselves in the group who cash in credit card rewards (in our case, we get Amazon gift certificates equal to 1% of our purchases) while never paying interest or fees.

The kicker, however, was realizing that if we ever had a major financial emergency (like if I lost my job) we'd have between one and two months complete spending already out there. Suddenly we'd be carrying a pretty substantial balance. And so we gritted our teeth and made the decision to step off the carousel voluntarily now, rather than finding ourselves pushed off at a time when it would represent a major crisis rather than a budgeting choice.

19 comments:

Anonymous said...

Dave Ramsey is arguably a 'financial guru', his advice is very basic common sense that's been handed down from generation to generation. He is, however, a motivator, and it works for a lot of people. I wasn't able to get past his bullying and adolescent name-calling, but maybe you can. Best of luck with your debt reductions - sounds like you're planning it out well and will succeed!

Kevin said...

Good Luck!!

Cliff said...

I hate to hear of people stuck in the mire of those evil credit card monsters. Been there, done that, still digging out.

You must not listen to the radio much, if you hadn't heard of D Ramsey. As I drive around from one job to another, I will often have the radio on.

Debt on a dryer, huh? You fancy Austinites must have rules against clotheslines. HAHA!

Good luck & God bless!

mrsdarwin said...

Indeed, I almost never listen to the radio, unless I'm in the van, and then I only listen to the classical station because the little pitchers in the back seat have an uncanny ability to memorize lyrics on a first hearing.

A clothesline would work perfectly in the summer, but our dryer broke in November. And even in Austin nothing is going to dry outside right now.

mrsdarwin said...

I should mention that the dryer was bought on a "one year same as cash" promo. Ramsey rails against these kinds of deals, but I have to say that we've bought three or four large-ticket items this way and never ended up on the wrong side of the equation. A financial advisor we know tells us that only about 10% of people who buy an item on a payment plan like so actually pay it off before the term is up, but we've found it an effective tool before.

Anon, I agree that Ramsey can wear a bit thin in his book. It was a motivator for us, but I don't know as we'd go back and read it again. I know what you mean about the tone of an author turning you off the message -- many Catholic mothers I know get a lot out of the time-management advice offered in A Mother's Rule of Life, but the author's personality so grated on me that I found the book useless.

Robyn said...

I'm a huge Dave Ramsey fan, and we've taken his Financial Peace University at our parish. I can recite the "baby steps" from memory:

Before the baby steps: Create a zero budget every single month. (Zero means every dollar has a name and there's none leftover to waste impulsively.) Also, stop borrowing, including credit cards.

1. Save a $1000 "baby emergency fund."
2. Debt snowball, which you described, for all debts except the mortgage.
3. Save a full-sized emergency fund, 3-6 months of expenses.
4. Start saving 15% of your income for retirement, using mutual funds (Dave is really against using stocks, which are not diverse enough for him, and claims to have made all his money with mutual funds).
5. Pay off the mortgage.
6. Build wealth and start giving.

Notice what's NOT on there: saving for kids' college (it's the same priority as #6, though I would put it between #4 and #5), using credit cards "wisely" for the rewards (it's like playing with venomous snakes—sooner or later you'll get bitten), or indeed ever borrowing money again, except perhaps for a 15-year fixed-rate mortgage with a big down payment.

That's right: No car loans, ever. I plan to keep that resolve, but first we have one vehicle to pay off. If your car loans are outrageously high, he'll tell you to sell them (even if it's at a loss, borrowing the difference—that's another small exception) and "buy a beater."

Even while you're doing the baby steps, you may (and should) save for specific future expenses, like a replacement car in case yours wears out—cash only. No vacations or restaurants; instead you eat "beans and rice, rice and beans." (We eat a bit more expensively than that, though not by much.)

We haven't had a credit card in over a year and we don't miss it!

Anonymous said...

As a former homeowner who got out of that racket a year ago, I am proud to say that I am completely debt-free. Truck is free and clear, like everything else I own. I keep the equivalent of four months' salary in the bank for emergencies.

I'm baffled by people who act like credit cards are evil. Have you ever tried to buy plane tix without a credit card? Or rent a car? I use my Visa for convenience, though sometimes it's actually necessary. I've paid it off every month for the past 10 years, have never paid any fees or interest, and in fact get 1% cash back. Given my emergency savings, the chances of falling behind on the card in the event of losing my job are zero, since the first thing I would do is pay off the card. I agree that cards are dangerous to people who buy stuff impulsively, but those aren't the kind of people who are ever likely to get out of debt anyway. So tell me again why I shouldn't have a card?

Joel

Anonymous said...

Robyn, by the way, since December of 1999 cash stuffed in a mattress has outperformed the S&P 500.

Joel

Cliff said...

Dear Joel, To say it politely, things happen.

Basically, the fine print informs you the credit card company is out to make money, it does not care what happens to individuals, and at the first opportunity, the poor sucker gets run over.

People can get in a bind for many reasons. Please Joel, keep in mind that Our Lord told us to feed the hungry, clothe the poor, etc... He did NOT tell us to analyze why they are hungry & naked, nor did He tell us to critique. Just feed, clothe...

For me right now, the best thing is to continue thinking of credit as "evil", if that is what it takes to dig out of my personal hole & get back on solid ground.

Peace. -Cliff

mrsdarwin said...

Joel,

I don't agree with everything Dave Ramsey suggests, and we don't think credit cards are evil. We don't plan to cut ours up or never use it again -- we just want to get out of using it for all our expenses, and the best way to do that is to stop using it for now and pay it off like a debt.

Meredith said...

Dave Ramsey is a much more engaging radio host than he is a writer. The enjoyment comes from listening to him talk tough or sometimes tender to callers, and it is a show I'm entirely comfortable having the kids hear. In fact I consider it the easy part of their financial education!

Anonymous said...

PS--I agree 100% on the Mother's Rule of Life book, Mrs. Darwin.

Darwin said...

Joel,

FWIW, I have no intention of ceasing to use credit cards for things like airline tickets, Amazon, etc. (Though, of course, one could also use a visa check card attached to one's bank account.) I myself don't think that credit cards are evil at all. I just think it's harder to stick to a budget precisely when it involves totalling up large numbers of receipts to see how I'm doing or checking my credit card's online reporting every couple of days. It's easy if there's a set resouvoir of cash, and if you run out, it's gone.

So I'm basically only interested in going to a cash economy as a forcing mechanism -- I think it'll be easier to budget that way. For the 200-300 in monthly recurring bills that I'll be leaving on credit card, I'll just set aside money to pay for those expected expenses.

Emily J. said...

I sympathize with your "I don't carry a balance" delusion. I hadn't thought about the two months in debt idea, but what if you keep track of the total you owe online and make sure you always have enough to cover the total in your savings account? I like the feature of categorizing your spending that our card offers, as well as the cashback feature. And having lost large sums of cash before, I would need a lot of convincing to give up the credit card.

Perhaps the thing that has helped us most with savings is having allotments made to the investment accounts before we even get my husband's paycheck. We were helped early on in our marriage, before we were used to having money to spend, by an insurance/investment company with a philosophy similar to Ramsey's that targets military members. While I wasn't extremely pleased in retrospect with their product, they did get us saving 10% in cash, investing 10%, and buying insurance. We add in another 10% for charity. What I am concerned about is the fact that we haven't done a heck of a lot of saving for college, but our kids will know before they start school that they won't get a free ride. Nor do I think they should. And while I'm a skeptic about projected life insurance needs, my husband has refused to let me alter our accounts when he is off to a war zone.

Melanie B said...

Mrs D.

I've had a Mother's Rule of Life post on my back burner for quite some time now. Need to dust it off and work on it some more.

I completely agree about the personality issue. (She admits herself that she's very "Type A".) I loved the idea of a Rule but found her one-size fits all application of the idea very trying. Not only in the book but on her website too. What perhaps drove me most crazy was that she doesn't at all address the situation and needs of mothers in the crazy years of when you have only infants and toddlers. Because she wrote and implemented her rule when she had kids old enough to help with chores, she sort of has a blind spot about what life was like before that.

Robyn said...

Joel, I use a Visa debit card or cash for everything except bills, for which I use my bank's online bill-pay service. I have not yet encountered a situation where one of these options did not suffice—though I admit I haven't tried to rent a car or buy a plane ticket with a debit card.

OK, there are some benefits to credit cards, but to me they are far outweighed by the costs: not only the fact that you are never truly debt free, but also the amount of monitoring they need to make sure there is no abuse from either identity thieves or the bank itself. Banks have been known to process payments that arrived on time after the due date in order to charge late fees. Under most contracts, they can change your rate and fee structure on a whim. I'd rather just keep track of my bank accounts. And I do my own budgeting to categorize expenses.

Dave Ramsey likes to cite a verse from Proverbs: "The borrower is slave to the lender." Words worth thinking about.

Amber said...

I found Ramsey too obnoxious and simplistic to bear when I checked his book out of the library a few years ago. A couple of years ago I found YNAB off of a comment on a blog. I really like YNAB - www.youneedabudget.com - His four rules agree pretty nicely with what Ramsey teaches, but I like his tone, methodology, and his software program a great deal. We're currently trying to dig ourselves out of some building the house related debt that we didn't roll into our mortgage (almost there, yippee!) and then we'll finally start saving again. But in the meantime, YNAB has helped us to live on last month's income which, while we still use credit cards, makes the credit cards not an issue because the money is already there to pay it off. It is so nice to not have to worry about timing payments and such anymore!!

Anthony said...

Ramsey saying to pay off the smallest balances first works well if you need to see signs of progress early on, but you're really better off paying down debt by interest rate, highest to lowest. So if you have $5000 at 16% and $2000 at 12%, pay off the $5000 first, because it's costing you more.

And budget for paying off those zero-interest specials when they're due, so you don't get nailed with back interest on them.

Tony said...

Almost 25 years ago, I married the most wonderful woman in the world. And with her came a native wisdom and frugality with regard to saving, spending and investing money.

1. Quit using credit cards

We use our discover card all the time. We pay our bill before it comes due and Discover rewards us for using their card by paying us around $250 / year.

2. Make a budget in which every last dollar of income is accounted for.

My wife has done this our whole marriage. My mom still jokes (somewhat snarkily) about my wife's "envelopes".

3. Save $1000 as an emergency fund.

We've saved much more than that. Part of it in easily spendible precious metals.

4. Start paying down debt (except your mortgage) with every extra dollar, starting with your smallest debt. Pay the minimum on all other debts.

The only debt we've ever had was our mortgage. We have always bought our cars with cash. In the beginning we couldn't afford very good cars. Now our cars are getting better (still bought with cash).

5. As you pay off a debt, roll that money into paying off your next smallest debt.

See 4.

6. Once your debt is paid, save a larger emergency cushion, perhaps equal to three months income.

See 3 & 4

7. Pay off your mortgage at an accelerated rate.

This we will not do. We have a great rate, and can invest at a better rate of interest. Also, we can write off the interest on our mortgage on our income tax.

8. Invest, Give, and Have Some Fun with your money.

We do that, but the keyword is "Some". I get an allowance, and I save up for toys that I want to buy. My latest toy is a Swiss K-31 rifle. :)