Money Smart Medics Part 5: Getting out of Debt

who-gets-paid-first-bankruptcy-bakersfield-caSo far in this series, we have talked about getting caught up on bills, writing our first budget and then mastering the budget. Where we really start to make progress is when we start paying off our debt, and that’s where this article comes in.

Before we go any further, I’m going to have to break some bad news to you: You have been lied to your entire life. You have been told things like “You’re always going to have debt” and “Not all debt is bad”. Then to top things off, you started working in EMS where it’s commonplace to see people driving a $40,000 vehicle on a $30,000 a year salary. We have been trained to believe that being able to afford payments equates to being able to afford the purchase. That’s a lie, and until you realize that, you’re never going to get ahead.

Think about it for a second, everywhere we turn we are being told that debt is just a way of life. When you go to purchase a car, the salesperson immediately starts talking about monthly payments and does everything they can to avoid discussing the actual price. You see commercials telling you that you can get 0% interest on the [fill in the blank] that you deserve. You even see ads where “small business owners” are talking about how their “Chase Ink” card somehow made them successful. Yeah, right. Go ask any successful business owner if they attribute their success to borrowing money on a credit card. Likewise, go ask every person drowning in debt how they feel about their credit cards.

By using credit, it delays the consequences of your actions. Unfortunately, we usually don’t feel those consequences until we have maxed everything out and can barely pay the minimum payments. Even then, we are still trained to pay those credit card payments on time before anything else. Because, you know, we might need that FICO score to borrow more money. It’s so bad that people will actually pay their credit card bills before feeding their family in fear of “ruining their credit”.

Do you see anything wrong with this?

Cause and effect is a very simple thing. If I spend my entire paycheck on a new set of golf clubs, I’ll have nothing left over until I get paid again. Talk about immediate consequences! How many pay periods of having absolutely nothing would it take for me to figure out that I need to be smarter with my money? With credit, we don’t have that immediate consequence so we continue to do things like this until we hit a brick wall later down the road.

Debunking the Myths

Like I said, people have been lying to you your entire life. I could write an entire book on this section alone, but for the purposes of this article, I’ll just lay out a few of the biggest debt myths out there.

You’re always going to have a car payment.

This one irritates me more than anything. It amazes me that we are so quick to accept the idea that we’re going to throw $400 a month away on something that will start to depreciate in value the second we drive it off the lot. But if you suggest that we put that same money into investments and grow it to well over a million dollars over the course of our career, we act like you’re speaking witchcraft.

No, we don’t have to have a car payment. Cars can be bought with cash. Of course, this means buying a car that we can actually afford which most likely means buying a car that’s 2-3 years old. Why 2-3 years, you might ask? Because cars lose the majority of their value during the first couple years. Let someone else take that hit for you. I’m sure plenty of people are going to respond by saying that “buying a used car means buying someone else’s headache”. Well, by that analogy, when you buy a new car, you’re buying your own headache. If you can’t pay cash, you can’t afford it. Get used to it.

You need credit cards to build your credit score.

You only need a credit score to do one thing: Borrow money. Sure, some employers look at credit reports and some services require a small deposit if you don’t have a solid credit history. However, I can guarantee you that any employer will be just fine with an employee that carries no debt and has a 6 month emergency fund. As far as the deposits go…so what? I would rather pay a deposit up front than accept the risk that comes with debt.

You need a credit score to buy a house.

NO YOU DON’T. There are plenty of mortgage companies that do manual underwriting, which means they actually look at things like your income, job history, savings, and expenses when determining how much money they are going to lend you. In other words, they actually make sure you can afford the house.

This part might seem a bit confusing as I just went on a big rant about how debt is bad. Yes, debt is bad, but paying rent for the rest of your life is bad too. You won’t see me complain too much when it comes to mortgages, only because you will have monthly rent payments if you don’t have a paid off house or a mortgage. Now, having said that, your ultimate goal needs to be owning a house that is 100% paid for.

There’s A LOT to cover when it comes to buying a house and that comes long after we start paying off our debt, so I’m going to save that information for a later article. The important thing to take away from this section is that you don’t need to worship the “almighty” FICO score in fear that you won’t be able to buy a house. You’ll be fine. Focus on getting out of debt and living within your means.

Why Get Out of Debt?

This section may seem a little redundant given everything we just talked about, but I think it’s extremely important that I drive this message home. The 2 following example scenarios will help to put the risk that comes with debt into perspective:

Employee A

“Employee A” is a paramedic that works for a private ambulance service. He has a $400 a month car payment, and typically carries a balance on his credit card. He does not set aside money for emergencies and he lives “paycheck to paycheck”.

He is seriously injured one day while riding his dirt bike (that he financed) and is unable to work. He can’t sell his dirt bike because it’s completely wrecked and the value has dropped far below the loan amount. He barely scrapes by enough money to make his rent payment and has nothing else left. He puts his utility bills and his daily expenses on his credit card. He tries to make his car payment on his credit card but realizes that his limit is too low. After 1 month of no income, he can’t even make the minimum payment on his credit card. His card is maxed out and now he can’t pay his utilities. After 2 months, he’s living in the dark and facing eviction and repossession of his car. You can probably imagine where the story goes from here…..

Employee B

Employee B works for the same service and makes the same amount of money. He drives a 5-year-old vehicle, but it was paid for with cash. He doesn’t have any credit cards and he maintains an emergency fund to cover 6 months of expenses and sets aside money in investments for retirement. He also started setting aside $200 a month last year to achieve his goal of replacing his vehicle within the next 2 years.

He is injured in a car accident and is unable to work. I could go on explaining how his scenario turned out, but I’m sure you can imagine. Did anyone show up to take his car? Did he have to go into debt to pay his bills? No. He has 6 months (and probably much longer if you factor in the money he had originally set aside to replace his vehicle) to focus on getting back on his feet before income becomes an issue.

With debt comes risk. Being able to “afford” payments is completely contingent on your ability to produce an income. The second that income goes away, your life gets turned upside down. Debt and income can mask bad financial decisions and can actually give the appearance of financial security, but you’re walking a thin line when you accept that much risk. Think about this when you wonder how your friends are “affording” nice cars and taking vacations all the time. It’s like Warren Buffett said: “Only when the tide goes out will you know who’s been swimming naked”.

Snowball Your Debt

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There are a lot of ways to pay off debt, but none of them will work until you STOP BORROWING MONEY. I mean it. Cut the credit cards, close the accounts and get serious about only buying things that you can afford.

I’m a big advocate of Dave Ramsey’s debt snowball method. Some people argue that you should pay off the accounts with the biggest interest rate first. Yes, that works…if you can stick with it. Being smart with money has very little to do with head knowledge and everything to do with behavior. The problem with paying off the highest interest rate first, is that it can be easy to lose motivation if you’re not seeing quick results.

The debt snowball method is simple. You list out your debts, smallest to largest. Then you start attacking the smallest debt with as much money as you can while continuing to pay the minimum payments on everything else. As you pay off the smaller debts, you get to cross them off your list and now you have even more money to attack your larger debts. It’s a process that has quick results and is very motivating. Yes, it slows down as you reach the larger debts, but having seen the immediate results of paying off your smaller debts, it’s going to be easier to stay on course. If you started with the largest debt first because it has a higher interest rate, you might find yourself giving up because it feels like you’re not making any progress.

If you’re making minimum payments on everything, continue to do so. Where things can get tricky is if you have debts that you already stopped paying on. I was in this situation. I had a bunch of accounts that I defaulted on that I hadn’t made payments on for in years. It didn’t make a lot of sense for me to start paying on those just because they were small, or “next in line”. I needed to get my monthly expenses down as fast as possible, so I actually created 2 debt snowballs. One with active debts (accounts I was still actively paying) and “stale” debts (accounts that had sat dormant for a while). Just pay off the active debts first, and then attack the inactive list with insane intensity.

Remember when we talked about budgeting? Well, a big part of your budget needs to be debt reduction. Add up all of your monthly debt payments and create a “debt reduction” category. Now, add anything that’s left over once you have cut your expenses down as much as you can. As you continue to pay off your accounts, smallest to largest, you’ll find that you have a lot more money to throw at the debt with each account that you pay off.

I highly recommend checking out Dave Ramsey’s debt snowball method on his website or in his book. It’s really an easy process and it does wonders for creating good habits.

Conclusion

Don’t believe the lie that you need debt. There is nothing in this world that can’t be paid for using cash. You just have to discipline yourself to be able to wait until you can afford what you want. The good news is, when you’re debt-free and not having to pay ridiculous payments every month, you don’t have to wait very long. You’ll be amazed at what you can do with your life when you’re not held back by the chains of debt.

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