Bye Bye Debt

If you are in debt, or have ever been in debt, you know how financial illness ails you. At times it seems worse physical illness, and you know you need to take steps to "recover," but it can seem impossible. Amid unexpected monthly expenses, where do you find the money to pay off debt? How do you get financially healthy?

While causes of financial ill-health are myriad as well, in most situations, we can zero in on two main deficiencies that contribute to our not-so-great financial health: lack of knowledge and lack of discipline. The lack of knowledge can be overcome by simply taking the time to inform yourself. On the other hand, lack of discipline is much more difficult to overcome.

For example, say you have several credit cards, each of which carries a balance. In most cases, paying off credit cards should be your first priority when you want to get out of debt. So now let's say you identify your Discover Card as the first you want to pay off. You do some spending cuts for the month and come up with $100 that you can use to pay down the balance. Excited, you make the payment and now your Discover Card balance is lower, effectively saving you money on your monthly finance charges.

For the next month, you do the same thing, but towards the end of the month, something comes up. Maybe it's an oil change you didn't remember that you would need. Maybe you needed to take a business trip and had to buy your food. No matter what "came up," it is these unforeseen, unplanned-for life events that can throw a real wrench in debt pay-off. So at this point, you have to take the money you had earmarked for your Discover Card and use it for something else. Now you're losing ground again, digging deeper into debt.

Finding a Model

What if you could arrange your finances and expenditures so that these unplanned-for events wouldn't get in the way? Is it possible to automatically fulfill your financial obligations so that discipline is not an issue?

Think back to the last time you took a close look at your paycheck stub. When you get that paycheck, do your eyes drop immediately to the net amount? If you do this, you are already taking part in an automated fulfillment of some financial obligations. The government has created a system whereby we get paid a gross amount, but we never see it, because deductions are made automatically, every month, to cover social security and taxes.

In the government's model lies the key to paying off your debt: you can automate deductions from what you receive as well, thereby eliminating the issue of discipline.

Steps toward an Automated System

Setting up a system that you can use to automate your debt pay-off is actually not very hard. The most difficult part of it is probably the fact that you will need to adjust your thinking, first by planning (not budgeting) your expenses, and then by using multiple bank accounts, instead of just two.

Mapping Your Expenses

To automate your debt pay-off, you will first need to take a detailed look at all of your expenses. With modern technology, this is easily done. If you use credit cards to pay for most of your purchases, you can simply take a look at your credit card statements. If you use checks or a debit card, look at your bank statements.

As you look over your expenditures, start categorizing them. You can do this by using one of the many money management software systems available or by using a table in MS Word or a spreadsheet in MS Excel. Your categories might include grocery, vehicle, home, personal care, clothes, and debt payments. If you have the income, you could also include a category for retirement.

Under each category, list every expenditure you make in a month. For example, under "vehicle" you will place gasoline or car washes. If you get an oil change every three months, take a third of that charge and add it to your monthly expenses. Since you probably register your car every year, take one twelfth of that charge and add it to your monthly vehicle expenses. Now think about what other expenses might be associated with your vehicle. Other maintenance, tire upkeep, and car washes should be considered. Figure what monthly costs there would be for all of those expenses and add them to your list. Finally, add about another 2 to 5 percent of your monthly expenses for your vehicle as a buffer against unforeseen events.

Now do the same thing for every category. What you are doing is creating a spending plan. This is not a budget. A budget, like a diet, tends to restrict and gives the feeling of taking your freedom away. A spending plan, on the other hand, works by the principle that money must be spent, but you should have a plan for how you are going to spend it and reach your financial goals.

When you have mapped out your expenses, with yearly expenses broken down into monthly amounts, you are ready to automate things. Automating will be simpler if you tend to use credit cards for most, or all, of your expenditures.

If you use credit cards for most expenses, you will want to designate which credit card will be used for what type of expenditures. You will also want to designate which spouse will be responsible for which categories. Because you have outlined a plan for your monthly spending for each category, you should be able to accurately predict how much money will go onto each card each month.

"Hub and Spoke" Bank Accounts

Right now you likely have two or three bank accounts, but the next part of this system utilizes several different bank accounts.

With the knowledge of how much you will spend in each category, you will next rearrange your bank accounts. Designate one savings account as your "hub" account. This is where you will have your paycheck electronically deposited each pay period. Now arrange either savings accounts which have bill pay associated with them or checking accounts as your "spoke" accounts. Each credit card needs to have its own spoke account. (Imagine a diagram with a circle in the middle and arrows going out from the circle; the circle is the hub account and each arrow represents a spoke or secondary bank account going toward your Discover Card, or American Express, or Visa, etc.)

Now you need to set up an automatic payment from your hub account to each spoke account. The amount that is automatically sent to each spoke account should match the amount you mapped out in your spending plan in the previous step. If you arrange these payments, and then use your cards as you would usually, each spoke account should end up with enough money to pay off the monthly balance on each account. Before we move on, however, we need to mention flexibility. Allowing for a small amount of money to go into each account each month, in order to cover unforeseen or irregular costs, will do you a lot of good. Call it "buffer money."

Now you can take care of accrued debt. While this process works well for a normal life in which you are endeavoring to maintain debt-free status, it also works well if you have been carrying balances. Consider the first example in this article. If you make spending cuts in a few areas, you can then add the money freed up to your automated payment system, thereby eliminating the desire to use that freed-up money for other purposes. On the other hand, you can also add another spoke to your automated system. This spoke can be called "debt payment." If you identify money you can free up from your monthly expenses, you can automate a payment to your debt payment spoke account.

When you have your automated payments to your spoke accounts arranged, you next need to automate your monthly payments to your credit cards. These monthly payments should primarily cover the amount you have charged throughout the month, but if you have the funds available, the payment can also go toward paying accrued debt down. In any case, arranging the automatic payments, can literally be done in moments.

Do you see the potential of a system like this? Sure, we are talking about opening several new bank accounts, but this will not affect your credit score. Also, if you choose your bank wisely, there should be no fees associated with your bill pay service or with minimum balances. While it might seem like this system complicates your life, in truth, once it is in place, it simplifies things.

Non-Credit Card System

Now let's apply this system to those who don't pay for everything with credit cards. You are going to do essentially the same thing, but your spoke accounts will have different names and purposes. Their names will be "debt pay-off," "vehicle," "grocery," and so on. You can even include "retirement" or "savings." Then simply automate payments from your hub account, and each spoke account will end up with the right amount of money to cover each category's monthly expense.

Again, this system might seem complicated. But if you take a moment to visualize how it can work to automate your expenses, and thus your debt pay-off, you will understand its power.

You might wonder if anybody actually uses this system. The answer is yes. There are thousands of people across the nation using this kind of system to help them reach their financial goals.

Once you understand the principles involved with the system we've discussed, it can be as flexible as you need it to be. This system puts you firmly in control of your financial well being. You can easily track each penny you receive - and this is a very empowering position to be in.

Einstein once said, "The definition of insanity is doing the same thing over and over and expecting different results." Sometimes we need to make serious changes in our lifestyle and money habits in order to get where we need to go.

Note:

Here are some banks to look into for the accounts associated with your debt pay-off system:

  • Chase Bank
  • HSBC (online bank; no brick and mortar office in most places)
  • Bank of America (despite the struggles they've had, they still have a good offering)
  • Wells Fargo
  • Zions Bank

Jared Garret is a professional writer, business marketer, and consultant. To contact him, e-mail jgarrett@wexlbusiness.com, or visit his blog at personalfinancegym.blogspot.com.

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