Apr

18

supercharging the debt snowball

Filed Under credit and debt | 21 Comments

supercharged

Yesterday, when I explained about Dave Ramsey’s debt snowball, I said that the biggest drawback is that you end up paying more by paying off your debts in order from smallest to largest, than you would if you paid them off in order of highest interest to lowest interest.

Now, unlike Dave Ramsey, who is hot on psychology, arguably the biggest finance guru in the UK, Martin Lewis - the Money Saving Expert, is all about the maths. If he made over your finances, he’d never have you paying off your debts smallest to largest, instead he’s pick the more rational choice to pay them off highest to lowest interest rates. Funnily enough, I’m pretty sure that Martin has never had a debt problem.

What if you could make it so that the smallest debt also had the highest interest, and the largest debt also had the lowest interest?

Then it hit me, that’s the outcome you’re aiming for when you use Money Saving Expert’s credit card shuffle. You can have all the psychological advantages of the Dave Ramsey method, whilst still getting the financial rewards of paying off higher interest debts before lower interest ones. And it doesn’t mean that you take on any more credit.

The time to do this is once, at the beginning when you’re setting up your debt snowball. (If you’ve already set it up, you might want to revisit it to see if you can save money with this technique.) You’ll need a list of all your debts together with total amount of each debt, the interest rate and the credit limit.

the credit card shuffle

Mostly, this works better with credit cards and overdrafts than it does with other loans - you need to check the terms of your loan to see if it will be worthwhile.

step 1: ask them to lower their interest rates

This is easy. All you need to do is call up each credit card company and ask them to lower the rate. They might just do so. If they do, make a note of the new rate.

step 2: find out about special deals

Whilst you’re on the phone to the credit card company trying to get your interest rate lowered, ask them if they have any special balance transfer offers for new customers - if there are, write those down as well.

step 3: the shuffle

This is the more complicated step. The idea is that you move your debt from the higher interest cards (or overdraft) to the lower interest cards.

Suppose you have 3 credit cards and an overdraft:

  1. Visa £1k balance, £3k limit, @ 6.9%
  2. Amex £2k balance, £4k limit @ 12.5%
  3. Overdraft £2.5k, £2.5k limit @ 13%
  4. Mastercard £4k balance, £5k limit @ 17.9%, (lifetime balance transfer deal @ 9%)

Here, we want to get as much debt as possible onto the Visa, then the new balance transfer from Mastercard, then the Amex, then the overdraft then finally, the old rate on Mastercard.

Firstly lets start by moving the most expensive debt onto the least expensive card.

  • transfer £2k from the Mastercard to the Visa

The Visa is now full up, but we still have £2k on the Mastercard. We can’t put this on the new offer, but we can put this on the Amex.

  • transfer £2k from the Mastercard to the Amex

At this point we have no debt on the Mastercard, and the Amex is full. The final steps in the shuffle are to use the special balance transfer offer transfer.

  • transfer £2.5k from the overdraft to the Mastercard (new balance transfer rate)
  • transfer £2.5k from the Amex to the Mastercard (new balance transfer rate)

After the shuffle we are left with:

  1. Visa £3k balance, £3k limit, @ 6.9%
  2. Mastercard £5k balance, £5k limit @ 9%
  3. Amex £1.5k balance, £4k limit @ 12.5%
  4. Overdraft £0k

The smallest balance has the highest interest rate, and the larger balances have lower interest rates. Everyone’s a winner (except the credit card companies).

Now, if you think that it sounds too complicated, on the Money Saving Expert site you can download a credit card shuffle worksheet to help you. Also, you only have to do this once, when you set up the snowball. Finally, even doing a little bit of a shuffle will save you money in the long run, and get you out of debt more quickly.

Hot or Not? Let me know what you think in the comments.

Image by The359.

Apr

17

the debt snowball

Filed Under credit and debt | 10 Comments

big snowball

Heard of Dave Ramsey’s debt snowball? No? Well, let me explain it to you.

The idea is that you take all your non-mortgage debts (credit cards, car loans, personal loans, secured loans, etc.,) work out all the balances on them, and the minimum payments. Write them down in order of the smallest balance to the largest balance, and add up all the minimum payments.

Then, slash costs wherever possible to get an amount of money that you can afford to put each month towards paying off your debts that is larger than the total of all your minimum payments.

Every month pay the minimum on each debt, and put the extra towards the smallest debt.

Once the smallest debt is cleared, put all the money that you were paying towards that smallest debt, and use it to pay off the next smallest debt. Repeat until all your debt is gone.

As you pay off each debt, the amount of money over the minimum that you can put towards debt repayment snowballs - hence why it’s known as the debt snowball.

advantages

The biggest advantage of this is psychological. Any plan for getting out of debt where you cut costs and put the excess towards your debts will work if you stick to it. The key words there are stick to it.

The magic of the Dave Ramsey version is that if you tackle the smallest debt first, you’ll pay that off quite quickly which will give you the psychological boost you need to believe that it will work, and so stick to it. If you stick to it, you will get out of debt - as ably demonstrated by a reader of plonkee money and my fellow bloggers Ana @ debt-FREE revolution, NCN @ no credit needed and JD @ get rich slowly.

drawbacks

No great plan is without its downsides and Dave Ramsey’s debt snowball is no exception.

Paying off your debts in order of the smallest to largest without considering the interest rate on each loan means that you’re pretty likely to pay back more than you would if you paid then in the order of highest interest to lowest interest, which would be the most mathematically savvy route.

Now, I understand that actually paying off your debt is more important than trying to do it as cheaply as possible and giving up because the task seems insurmountable. But, it’s also a good idea to try and get out of debt as quickly as possible, and the less you’re going to pay the less time it will take.

a brainwave

Breaking things down into bite-size pieces and getting in some quick wins is a good idea.

What if you not only got the psychological boost, but also used some cunning thinking and a little bit of time to supercharge the debt snowball?

Come back tomorrow, and I’ll explain the idea :) .

Image by star5112.

Jan

18

why i’m not paying off my student loans early

Filed Under credit and debt | 14 Comments

graduation

Debt reduction is very popular in the personal finance blog world. Some of my favourite blogging friends are trying to reduce their debt (including being frugal, I’ve paid for this twice already…, single guy money, credit withdrawal, rocket finance, gather little by little, and others).

I have two major debts, the largest is my mortgage which weighs in at over £86,000 (about $172k). The other debt that I carry is my student loan, which originally totalled £12,000 (~$24,000) and is now down to around £9,000 (~$18,000). I’ve got no intention of paying off my student loan early at all.

I took out a loan for each of the four years of my degree course from the government backed Student Loans Company. There are three unusual factors about this loan which lead to me to decide not to pay it off early, they are as follows:

  1. repayments are income contingent - 9% of earnings above £15,000 (~$30k)
  2. if I haven’t paid it off by the time I’m 65, or if I become unfit to work, it will be written off
  3. interest is pegged to inflation

Why do these lead me to not pay it off earlier?

paying off slowly is risk free

The last two features combined mean that if something unforseen happens and I have a much lower income, or I am unable to work, or even if I get stuck in a minimum wage job, my student loan will not hamper my life further. If my income is lower, my repayments are lower, and I won’t be retiring with this loan still over me. It is safe for me to pay the minimum for as long as I like.

paying off slowly makes money

If I continue to pay it down at my current rate, it will take me another 10 years to pay off my whole student loan. At the moment I have about £200 of spare money a month that I could use to pay off my student loan early. If I used this money to pay down the loan more quickly, then I calculated that I could do it in about 2.5 years.

However, I could take that £200 and instead of using it to pay off my student loaninvest it in the stock market tax free via a stocks and shares ISA.

Assuming that there is always £200 plus my student loan payment available per month, either for debt reduction, or for investing in the stock market, that inflation is a relatively high 4.5%, and stock market returns are a reasonably conservative 7%, I would be £1,300 better off investing in the stock market. £1,300 is a lot of money.

disadvantages of paying it off slowly

The only disadvantage I can see is that I don’t get to experience the much vaunted debt-free feeling. I have it on good authority that it’s very satisfying. I don’t know, I’m in this for the long haul, and I think £1,300 will be very satisfying. And over the following 30 years to retirement, that £1,300 (assuming 7% returns) could grow into nearly £9,800. And that’s a very, very satisfying indeed.

what have i really done?

I really am investing £200 in the stock market (in pension and ISA, switching to an ISA only in April), and paying off my student loan as slowly as they’ll let me. Eyes on the prize.

Image by tompagenet.

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