Gwen came home recently to find her wife, Sami, sitting at the kitchen table with bowed head, folded hands, and a solemn expression on her face. Mind racing, Gwen knew immediately it was bad news. “I just can’t stand it anymore. I’m tired of being broke,” Sami finally offered. That was it? Gwen had been terrified that it was going to be something with Sami’s health, which had been holding steady in recent months, but this? Sami came home from work and found a letter in the mail from their former cable provider, claiming the final bill had never been paid, and was being sent to collections. Sami was certain they had paid it, didn’t they? What Sami did know for sure was that the collection notices and phone calls were bad for both her health and her relationship.
They had one credit card maxed out, and another on the brink of going to collections. They had Gwen’s student loan, and car payment, which were both current. They also had an old cell phone bill and two medical bills in collections from when Sami fell ill and needed hospitalization. Sami could easily forgive herself for the medical debt, but the others just felt reckless. They simply couldn’t understand where their money was going. They began to open and read statements they had long since ignored and were shocked to realize that they were spending exorbitant amounts of money dining out, which included more than $500 per month on coffee alone! Both women made decent incomes and were ready to face the music.
There are two things that Gwen and Sami, or anyone in their situation need to address immediately: the budget and debts.
The first step is to compare your spending with an ideal budget. Make a list of monthly bills and dollar amounts, and place them into categories: necessities, goals, and lifestyle. In Elizabeth Warren’s 50/20/30 Rule, necessities should comprise no more than 50% of your income, with goals at 20%, and lifestyle at 30%. Within the “necessities” category, housing should be less than one-third of your income. Gwen and Sami’s necessities came in at 51% of their income. They’ve only been making the minimum payments on their current debts and aren’t saving any money at all. In other words, Gwen and Sami are only spending 6% of their income on goals, which leaves a whopping 43% being allocated to lifestyle spending. Arguably, since they’re adding more debt each month, they’re spending more than 43% of their income on lifestyle.
Next, have a monthly budget meeting before the month begins, giving every dollar a name, and addressing expenses that only come up periodically. By utilizing the full 20% in their “goals” category, and temporarily cutting some lifestyle spending, they can progress rapidly. The key to success with minimizing lifestyle spending is to realize that sacrificing lifestyle spending now will allow a greater lifestyle in the future.
Staring debt in the face is the first step toward freeing yourself of it. As you collect information on your debts, make two lists: current debts and debts in collections. Create two separate debt snowballs. You’ll start with the current debts. Pay the minimum payments and apply all extra money to the smallest balance until it is paid off. Then the money that was once used for that minimum payment gets added to the extra funds being used to attack the next debt. Upon reviewing their numbers, Gwen and Sami realized that they could be free of the “current debt” in seven months, and that’s after saving $1,000 plus their entire tax return for emergencies, so as not to be forced to use a credit card again.
Once all current debt has been eliminated, they should aggressively save money. Once they’ve got enough money saved, they can contact one of the collection companies and offer to settle an old debt for significantly less. This is a proven strategy, but only works if you have the money available. Make sure you have the agreement in writing stating that the dollar amount agreed upon will be settlement in full. Never give the collection company electronic access to your accounts. Always pay with a cashier’s check or money order, and always keep a copy of the agreement and proof of payment because unfortunately, they’ll often try to pursue collecting the same debt from you again.
We all have a financial past. By forgiving ourselves, coming up with a plan, and seeing it through, we can all live our best financial lives.
Alacias Enger is a performing artist, writer, and educator. She lives with her partner in New York City, and is the founder of blogs “Sense with Cents” and “Travel Cents.” Follow her on Twitter @sense_w_cents.