Wednesday, October 22, 2008

Debt snowflake

There's a concept in the on-line frugality community of the "debt snowflake." I think it was developed by Dave Ramsey, but I found out about it through Get Rich Slowly, which is about my favorite of the many frugality sites on the net these days. As explained here, the idea is that you set a certain amount to apply to your debts every month above the minimum payments , and all of that extra money gets put into one priority debt: it could be highest interest debt, or the one with the lowest balance, which seems counterintuitive but the idea is that success at eliminating "low-hanging fruit" will be a positive reinforcement toward continuing to pursue future goals.

Then, whenever you come into some money - whether it be a repaid $5 loan from a person at work or a tax rebate check, a high holiday pulpit, whatever - you apply it to the priority debt. That's the snowflake, which builds, presumably, into a snowball. This gets the priority debt down faster, and then once you have paid off that debt you take all the money you've been paying toward that debt and apply it to the next priority debt, and so on.

It sounds pretty smart to me, so I've been trying to adopt it for the past several months. I also found, probably through GRS though I don't really remember now, software for an Excel spread sheet that helps make this a visible, workable plan. You load in all your debt numbers, interest rates, and the amount you pay each month, and prioritize which debt to attack first, and it figures out how long it will take you, and how much money you will be able to apply to other debts once the priority debts are resolved. There's a place for you to enter in any additional money that you can snowflake, and it automatically readusts the calculations to take that additional money into account.

So I have 4 major, priority debts: two credit cards of about $7,000 balance each, one at 19.9% interest and one at 13%; a car payment of $340 over 72 months, which we're a little more than 24 months into; and about $7K to one of my brothers-in-law, which was mostly to buy our way out of the house in IL. (I also have my student loan debt, which is $400 / month but which I'm leaving off here for right now because the interest rates are low and the other debts are higher priority.) Given that there isn't any one particular debt that has a significantly lower balance than the others, I'm prioritizing the 19.9% credit card. So I pay $400 monthly to that, $200 to the other card, the $340 for the car, and $100 to the brother in law.

According to the calculations, if I don't incur any additional debt, the first card will be paid off in June of 2010, and the second one, taking into account the additional $400 per month that I will then be able to add to the payments, will be paid off in January of 2011. Then we apply the two additional amounts to the car payment, etc. etc. If nothing else changes, these 4 debts (again, leaving aside the student loan) will be resolved in November of 2011.

Which doesn't really seem that far away, when you think about it. The problem, of course, is that many things will happen between now and then to complicate these calculations. We have the looming orthodonture issue that I wrote about earlier; we want to send DK1 to Jewish summer camp next year; and we have a bat mitzvah on the horizon for August of 2011, right in the middle of all of this. (Stay tuned for a large expansion of the "frugal bar mitzvah" tag starting in about a year or so!) We also haven't been saving for retirement or for college for over a year now, since we got to Wichita.

I suppose the unexpected could happen in a positive way as well, such as DW getting gainful employment which would allow us to raise the numbers, or at least not add to them because of tight circumstances. Right now we have about $2500 in our savings account, which means we wouldn't have to go to the credit cards if we had an unbudgeted expense, such as needing to do a repair on the car, for instance.

So it is what it is, it seems like a good tool, and I think in this case it's useful to have things written down. It makes the thing less liable to vagaries of my mood or the balance in the checkbook. I'll let you know down the road how it's working out.

Oh, and one other thing: every once in a while I find myself moaning because things are tight at the end of the month and it seems that we're not being frugal enough. But one thing I've realized through paying closer attention is that I am paying about 25% of my monthly net income in debt service, so it's no surprise that things can get tight. That's no reason to let up, and I still think there are more economies to be found, but I also think relief will have to come on the income side, if you get my meaning.

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