Reader Question: Help me figure out where to allocate my cash

The “Sitch”

College student who lives with boyfriend, and they own a house together but he pays the mortgage and bills associated with the house.

She works 24 hours a week and makes $890 a month (all after tax).

Her goals are to pay off her $4900 credit card debt first (interest rate is a shocking 29%), start an emergency fund of $15,000 and pay off her $8800 college loan debt as well.

This is just for reference only so that you understand that the basic home living expenses and other necessary items are taken care of in another person’s budget.

I am not going to touch HIS BUDGET because it’s his money and the guy is actually under by $315/month as per the numbers given to me.

I can see where he can gut a couple of categories like the gym, lawn care, or trying to conserve electricity, but to me, the budget is fine where it is albeit a bit skimpy on the savings part since he only saves about $75/month and that is 2% of his income, when it should be 10% of his income at $320 a month.

But I digress.

It’s HER BUDGET that we will be focusing on.

One last note: She has $5700 in monetary assets and her boyfriend has $40,000 in monetary assets.

I am not taking those into consideration because I don’t like the idea of raiding retirement funds unless it’s TRULY necessary, like a medical emergency that is crippling you…

HER BUDGET Questions:

How much can I realistically spend on credit cards every month? Is $250 the maximum I can pay on my credit card here?

Do I really need a money market or a retirement savings when I could pay off the credit card debt faster without it?

And how realistic is it that we could live with me earning about $550 a month if I were to drop down to another job?

If I paid off my credit cards – is that doable to drop to $550 a month?

FB’s Answer:

I want to remind you about the following:

With that being said, let’s go ahead with my assessment.

You are already over budget by $48, if the budget category numbers you have provided me are accurate.

So actually, no. $250 a month is not what you can spend on your credit card based on your above budget. You can only spend $202 a month in clearing your debt, but this is a bad, bad idea as I will explain later on in the post:

You are clearly not tracking your expenses, which is totally fine since you’re starting out, but my first suggestion would be to track your expenses.

You need to REALLY know what you’re spending and where. I can imagine that the Internet and Cable expenses are en pointe, but I can tell you that when I started doing my finances, I thought I was only spending $50/month on clothes.

*snort*

I was clearly living in La-La land because it ended up being on average, $200/month.

But I didn’t know that because I didn’t have accurate numbers, and the only way to get accurate numbers is to track your spending. Period.

Which of course, means that if you decide to keep to that budget, you will need to cut back on around $48 a month (based on those budget numbers).

I also don’t want to scare you, but the reality of what you spend is normally worse than what you can imagine.

I was overspending by $800 – $1200 a month when I first started tracking expenses, and I was shocked. I didn’t know I was over by that much, and it made me realize that I was living in a fantasy where I earned $65,000 a year and not my true after tax net worth of $50,000.

I really hope it isn’t that case for you, but that is my first suggestion.

Based on the above budget, you CANNOT afford to drop down to $550/month in income.

You would then be $600 over budget.

I have done a quick budget chop for you, and to spend (truly spend) only $550 a month, this is what your budget would look like:

As you can see, it’s pretty bleak on $550/month.

Let’s go over the categories and why I made those decisions for you in detail. All the budget categories in red are the ones I eliminated or chopped down, and the green ones are the ones I kept.

Internet: I dropped you down to dial-up. It sucks, but it’s what you can afford given what you’ve told me

Cable/DirecTV: You don’t have money for entertainment, girl!

Your entertainment will be reading books from the library or borrowing DVDs from the library for free.

Flower Planting: I’m afraid the flowers will have to stop. However, I hear fake plastic ones keep their colour and don’t die even in winter. Score. But in all seriousness, you cannot afford to plant flowers on your budget.

Gas & Parking: I don’t find this amount particularly excessive, but if your bus pass can get you to your school and work for only $50, then you should do a super, crazy CHOP on those categories and take the bus.

It sucks, I know.

I took public transportation for 25 years because I couldn’t drive, and once I got my car, I couldn’t believe I put up with that waiting in the cold for 45 minutes and all the other shenanigans that came with taking transportation for 25 FRICKING YEARS.

So I kept it the way it is, because I don’t know where you live (in the country?) and I don’t think you have a bus going out there, if you are 34 miles away.

Money Market Savings: You are already saving money in your Emergency Fund.

Hair: I would suggest you cut your own hair, but if you can get your hair cut for $20 which I think is fairly reasonable, then go for it.

Health Expenses: I kept them the same as requested.

Gym: I love the gym too, but you can find cheaper ways to stay fit. Walking is one. Taking the stairs instead of elevator is another. Eating better helps.

Charity: Bottom line: you cannot afford to take care of other people when you can barely meet your own financial obligations.

What good are you to others financially if you are in the weeds as is?

Some people believe in a 10% tithing all the time, and I know you sit on a couple of charities, but you have debt, and credit card debt at 29% is no joke. It is truly astounding how much interest you pay on that.

$4400 x 29% = $1276 <– that is what you pay in interest ALONE each year on your $4400 credit card debt

Postage/Stationery: I am not sure why you spend $5 a month, so I just cut it out.

Credit Card: This was the left over from my chopping, and it is actually $10 less than if you earn $980 and kept all your other bills.

Loan (Grandma): If she doesn’t need the money, then I suggest talking to her and asking her to put the payment on hold until you clear at least your credit card debt.

OR ask whether it would be all right to pay $25/month instead of $50/month. You need to work something out here, or else you are going to be paying even less on your 29% credit card.

Retirement: I chopped this completely, because you are definitely not earning any money in the market right now, rates have dropped into the negatives, and with credit card debt at 29% you are not doing yourself any favours.

Assuming the average rate of return this year is -15% (making this number up), and you have credit card debt at 29%, then:

-15% – 29% = 44% is what you are losing by putting that money into retirement instead of clearing your super high interest card card.

Emergency Fund: I kept this at $25, because you need to save at least $1000, or a month’s worth of emergency cash before you can decide whether to keep going with the EF savings up to $15,000 or to funnel everything into debt.

So, I guess it’s pretty clear that I am telling you that you should not (if you can help it), drop down in your income.

Do NOT take that job at $550/month, because you will not only have that situation above, you will be paying less than $10 a month on your credit card debt to boot.

You need to make more money or cut back even further

Since we basically snapped your previous budget in half, giving it the good ol’ axe, your only option is to make more money.

You need to find the time to pick up another part-time job if you want to keep those expenses above.

If you cannot live without charitable donations, or DirecTV, then you need to make more money, because at the rate you are going, paying $250/month towards your credit card debt, you barely cover the interest.

Let me explain :

(Note to all math whizzes, I am using very simple numbers here, not accounting for lower interest payments each month because the balance keeps dropping)

Right now you owe $4400 on a card, at 29% interest per year which is an interest expense of $1276/year or $106.33/month.

You are paying $250/month.

$250 – 106.33 = $143.67

You are only clearing $143.67 in the credit card principal each month.

It will take you 30 months or 2.5 years to clear that credit card, and in the mean time you will be paying roughly $3189.90 in interest ALONE in those 2.5 years.

And to tie in to what I said in the beginning, based on your current budget and getting rid of the $48 deficit by paying less on your card, if you only pay $202 a month towards credit card debt, then you are only paying $95.67 towards the principal each month which is much too low, and it will take you 3.8 YEARS to clear that debt.

Of course, if we assume that each month your principal drops by $143.57, you will get out of debt even sooner, but not much sooner. It will still be be around 2 years, as my best guess or $2551.92 in interest being paid.

I should note that I didn’t take another factor into account: this interest is probably compounded daily and not YEARLY which makes it even worse.

Why? Because I see it on all my credit card statements – compounded daily rate of 0.0019%, but it all adds up to a nastier interest number than if compounding interest were to kick in at the end of the year. I should do a post on that one day.

You can also call and tell the credit card company:

Look [bitches], I want a lower interest rate, and I don’t like that interest rate hike you did from 19% to 29% just because you’re losing money. I am barely making the payment as is, and if you don’t give me a lower interest rate, I could just as easily default on this entire credit card amount and you won’t get anything at all but pennies on the dollar.

It’s worth a shot but you have to play hardball with them. Many people have lowered their credit card interest rates successfully and 29% is murderous.

I have never done that before (never needed to) or else I’d direct you to my own post, so Google “how to lower credit card interest rate”, and I am sure you’re going to get a ton of hits on the web about this.

Now let’s look at a more realistic budget

Assuming you stay at your job for $890 a month, I am positive that you can cut back or eliminate some of the expenses on your list.

Here’s my new budget for you, based loosely on the principles of above.

Not bad huh? You end up paying $552 towards your credit card debt, which will mean that you are going to kill that debt in approximately 10 months.

Much sweeter than 2.5 years right?

And you will only pay $1049.77 in interest, saving $2140.23 in interest payments.

Sweet.

If you don’t have the time to work more then you need to find the time.

You won’t have entertainment, and maybe you can stop volunteering for the charity to get the time, to find a quick job (cleaning houses I hear, makes some good cash) and MAKE MORE MONEY.

This is the fastest way to get out of debt. If you aren’t willing to cut back even more in your bare bones budget that I gave you above with $890/month, then you need more cash.

It’s as simple as that.

Shovel snow. Mow grass. Babysit kids on the cheap. WHATEVER.

You should not drop to $550/month if you clear your credit card debt

Wait. I’m wrong.

Technically, you can.

Here’s the budget where I chop out your credit card payments and you dropped in income to $550/month:

Look, I even put Charity, Internet, a couple of flowers, and a better hair cut to boot!!

It is a beautiful dream if you can work less and earn less at $550 and still make the budget balance (like above).

But you aren’t saving enough in my opinion, and you aren’t thinking about your student loan coming up at $8800 and I find the bare bones budget quite harsh.

Let’s go over what you are going to be doing:

1. You are going to pay Grandma off sooner.

I upped that to $100 a month. Alternatively, you can continue to pay Grandma $50/month, but save the other $50 aside as a cushion to put towards your student loan coming up so that you can pay down a big fat chunk towards it to reduce the interest rate payment from the get go.

2. You are going to save more money.

This is my rough savings outline, but if you want to put more in Retirement because stocks are on sale right now, then go ahead. But I would like to strongly push the idea of building up a strong EF fund and Savings fund because you need at least 6-8 months worth of savings because anything can happen.

$50 in a Retirement Fund
$200 in an Emergency Fund
$100 in a Money Market Fund

Don’t worry about those set numbers, the basic idea is that you are going to save $350/month. Whether you put it all in Emergency Fund until $15,000 or third in each.. whatever, it’s all up to you.

Just save more.

3. I am trying to keep to your old budget because it’s not MY budget

… but you know my feelings on flowers, charity and TV. If you can cut out those things and put more money in your Emergency Fund or towards clearing your loans (Grandma and student loans), then please do.

But I understand. To some people, Charity and having a wonderful flower garden is non-negotiable. It’s totally up to you and the priorities that you decide are more important over others.

FINAL WORDS

You’re actually quite lucky even if you don’t know it.

$4400 in credit card debt is very small compared to other people out there who call in, and panic because they have racked up $40,000 in credit card debt.

THAT, is scary.

You are still low enough in debt to get it cleared quickly with some smart decisions that have to be made now, and not 2 years later.

1. Clear your credit card debt as soon as possible (ask for lower interest rate, pay more than the minimum interest rate each month)

2. Stay at your job and/or make more money

3. Keep saving for an emergency (you never know)

Readers, can you please offer some tips and help?

Or correct me if I’m wrong in my assessment, or point out anything I’m missing to help this reader out?

Thanks.