Personal Finance Part 2

On “Personal Finance Part 1″ we talked about starting a budget, how to do it, and why it is important. Today, I want to use some resources from Crown Financial Ministries to explain the importance of personal financial management and help everyone get started on the road to financial freedom.

Let me share some personal information with you first. Thankfully I have been blessed to have been raised in a household where my parents were knowledgeable about finances and financial management. I have been able to live at home rent free through college. I am one of the thousands of college students though who has credit card and student loan debt. I guess another plus is that I really enjoy personal finances and how the financial system works so I know some of the financial system’s and operations which helps in my decision making. Several years ago, I discovered Crown Financial Ministries. They are a Christian ministry organization that helps individuals realize that they are not the owners of their possessions or money, but the stewards of “stuff” and money, give to them by God.

This understanding of money and possessions helped me to understand that I need to take good care of what God has entrusted me which caused some additional motivation. Of course, there is also the feeling you have when you are debt free, have money and savings and don’t have to worry about the finances, and that is all good and fine. The thing that I learned, and that others need to understand, is that God is trusting you with resources that should be properly managed.

I began listening to Howard Dayton’s radio show through Crown, and learned a lot about how to handle money, what is acceptable and what is not from a Christian perspective when dealing with topics such as cosigning (never do it), buying a home (have 20% down to reduce your payment and eliminate the need for PMI insurance) and much more. I also discovered a wealth of books, resources and aids in planning out my success in financial freedom. Perhaps the most helpful resource by far, which I still use today and even have it posted in my room, is the Crown Financial Ministries “Money Map”. This is a visual guide which walks you through the 7 main steps to “True Financial Freedom”. This freedom is where you are 100% debt free (including the house), have several months worth of savings, college funds (if you are planning on having kids) and retirement is fully funded.

The budget, as discussed in the previous post (Personal Finance Part 1) is a key to every step of the “Money Map”. Without it, you will have a hard time making good on your goals in your personal finance life. If you have not read that post, please do so! So, with that background information, let’s get into the first 2 steps of the “Money Map”.

STEP 1: SAVE $1,000

This is your emergency fund that I was discussing in the previous post and the first destination on the Map. Believe it or not, saving this money will actually help you get out of debt. Let’s say you are prone to spending on your credit card when times are tough or an emergency arises. Having this money available to you for emergency use will help to pay for that emergency in cash instead of on your credit card. The hope is that you will begin to limit your credit spending. Cash is a good thing and hardly anyone has any on hand. According to US News, the average American has a savings rate of -2% to 0%! We are spending more than we are making and that is not a good thing!

I mentioned in the previous post that you should begin to a lot yourself money every payday to put towards savings. This should be an ongoing, continual process. In this step, pay only the minimum balance on your accounts every month in order to get your savings up to the $1000 mark. Once you have reached this amount, you will continue to save every month, but you will reallocate funds in order to begin paying off your debt. Remember, your budget, or spending plan, is dynamic, not static. Keep making adjustments and fine tuning the document in order to get the most out of your debt repayment and savings.

STEP 2: PAY OFF CREDIT CARDS

Credit cards are not evil. I just want to state that up front. It is the way in which we use them that is evil. It is a dangerous thing to have so much money just lying around, readily accessible. This is especially true if you are an emotional spender. In step 2 of the “Money Map”, once we have saved the $1000 for emergencies, we need to begin paying off the credit cards. I have actually just finished this step this weekend! Let me tell you how to do it.

Have you ever heard of the “Snowball Effect”? This is a payback method you can use to pay back your debt and it works really simply. You can do this one of 2 ways: based on interest rates, or based on balances. I prefer to work with the balances so that is what I will use in my example.

Billy, our example, has 3 credit cards, each with a balance. They are as follows:

• Bank of America: $2000 @ 4.5% w/ min. payment @ $15/mo
• Chase: $5000 @ 10% w/ min. payment @ $20/mo
• Washington Mutual: $12000 @ 12.25% w/ min. payment at $100/mo

To properly use the snowball effect on balances, Billy is going to begin paying off the card with the lowest balance first which is his Bank of America card. Notice that this card has the lowest interest of the three. You could argue that Billy should pay off the card with the highest interest first, and that would be a valid argument (and actually the way in which you would use the snowball effect based on interest rates). The reason I would recommend to pay off the card with the lowest balance is it creates a sense of achievement and excitement when you pay off your debt. Paying off Bank of America would give encouragement, and create a noticeable change in the Net Worth and total debt. If Billy chose to pay off the Washington Mutual account first, he may be saving money on interest charges, but it will take him longer to pay off the account, and that would leave relatively smaller balances on the other cards creating a distraction and frustration.

So, Billy will pay off the Bank of America card first. In order to do this, his spending plan (budget) has changed to accommodate the allocation of funds. No longer will he be putting as much money in savings as he was before. Instead, he will continue to put money away every month, and pay the minimum balances on his Chase and WaMu cards, and begin adding some additional funds over and above his minimum payment at Bank of America to begin paying down principle. If Billy removed $50/month from his savings allocation, he would be paying a total of $65/month to his Bank of America card. When you pay more on principle, you reduce the amount that is applied to the finance charge each month, saving charges on that card.

Once the Bank of America card has been paid, Billy will move to the Chase card. Now here is where the snowball effect really takes its shape. Billy will pay the minimum amount due on the chase card every month like normal, but will place the money he was paying off his Bank of America card with onto his Chase card. To put this into a mathematical equation, it would look like this:

Chase = Min. Chase Payment + Min. BofA Payment + Principle Payment OR Chase = 20 + 15 + 50 

The same approach would then be applied to the WaMu account once the Chase card has been paid off, and that is the snowball effect! Keep in mind, you can allocate your budget however you want, add more to the card when you have some extra to spare and so on. It is entirely up to you!

TIPS TO STAYING THE COURSE

Depending on how much debt you have, it may take a while to complete these first two steps. I have personally been working on the “Money Map” for about 2 years and just finished step two this weekend. I am now moving to step 3 which we will cover in the coming days.

To stay motivated, set a goal, or way to celebrate when you complete each step. For example, after completing step 1, buy yourself a new pair of shoes, or a CD or something special. Just be sure that you budget for that expense and it is not going to undo what you just completed. That is important. 

Another tip is to get an accountability partner, someone who can help you adjust your spending habits, save your money, and keep you accountable in paying off your debt. Having someone to talk to can help alleviate stress and financial worries as well.

Well, that is it for this post. I know it was a little lengthy, but I though that I had to cover the first two steps for you to get an idea of why saving first is so important for the rest of your getting out of debt. 

I highly recommend that everyone purchase the Crown Money Map from Crown Financial Ministries. It will help to serve as a reminder and help to keep you on track. I would also recommend the book by Howard Dayton called “Your Money Map” which is a guide through each and every step of the “Money Map” and even includes a small, fold out map in the back. Great resources. The picture of the book is below.

Good luck on your journey to financial freedom. As always, feel free to email me with your questions or comments! brent.a.downey@gmail.com

Brent