Basic Budget – Evaluate debt

Now that you’ve started writing down each of your purchases in that pocket notebook, let’s start to look at debt.

Categories

Keeping inline with KISS, let’s identify overall categories for your debt. This can be things like credit cards, medical bills, collections, student loans, personal loans, car loans, mortgage, etc. Again, for the credit cards, we’re not yet drilling into where the money goes, we’re still trying to establish a baseline.

Write down each debt category you currently have, how much you owe and what the interest rate for each is.

Prioritize the List

The next step is going to be prioritizing that list. Before we go any further, if you have accounts in collections, make sure there is no interest being applied. When I personally went through this process, there was no interest on my accounts in collections so they immediately dropped to the lowest priority. Medical bills may not be charging interest either, but check. If there is no interest on those too they get a lower priority.

We should now have enough information to prioritize the existing debt. If you are carrying a mortgage and/or car loan, I would suggest putting those as the top priority. You need a place to live and a way to get to and from work. Also, if you have any other loans against either your home or car, put those as top priorities as well.

Wait – we have a problem. If you read above closely, twice I mentioned ‘top priority’ and each time I did, I assumed 1 ‘or more’ items. You can’t do that. One thing I learned in my career from a great boss and mentor, was you cannot have more than 1 top priority at any given time. Something may come up that ‘changes’ the top priority, but you cannot have more then one top priority. Changing a top priority should never be made lightly either. After all, if something IS a top priority there’s a reason why. Let’s talk a little bit about the process and then prioritize the debt. The output from our prioritization is going to be a list and each entry in the list will be ONE item.

Approach

Let’s look at the remaining loans, credit cards and any other debt. There are actually two different approaches.

1. List all debt by interest rate first followed by amount due.
2. List all debt by amount due (from lowest to highest) regardless of interest rate.

Again, when I went through the process (and I had no mortgage or car loan), I used approach 1 above. Those higher interest rates were costing me money. Having said that, when I recommended this approach to a friend years back, they complained that they weren’t getting results fast enough. They were, but that instant gratification of scratching something off the list wasn’t occurring fast enough for them. Having a plan isn’t ever going to work if you aren’t going to follow it. In this particular case, the plan was modified to use approach 2 above. That helped my friend stay motivated and work the plan. He still ended up paying more in interest, but he DID work through all his debt. Below I’m going to use approach 1. If you rather use approach 2, so be it. The important thing is to stick to your plan.

Get Started

Let’s start on that list.

1. (top priority) mortgage (if you have one) – if you have multiple mortgages, list them out (one line item each) by interest and amount
2. car loan (interest, amount)
3. Sort all remaining loans and credit card balances and record them (highest interest to lowest, with balances)
4. Sort all remaining non-interest bearing accounts (like collections, medical, etc) Since there is no interest being charged, approach 2 from above is fine (list by lowest balance to highest)

If you’ve gotten this far and actually did the work, congratulations. You’re on your way to establishing a good baseline to getting a handle on your existing debt. We still have some things to do, but I like to follow the KISS approach and take short achievable steps.

More to come…..