Friday, October 15, 2010

budget bootcamp week 3: debt repayment and the 10-10-80 system

budget bootcamp logo 2

Last week we were looking at how we can create a jar system and sinking funds.  How did you do?  I’ve been doing envelopes for groceries and gas for a little while now, but I needed some accountability for household and dining out categories (what can I say, shopping and eating out make stay at home mom’s to newborns lives easier and a little more fun!), so I made up a few more jars.  We get paid tomorrow so we’ll see how much of a difference it’s made!

One thing that I probably should have mentioned earlier in the series is the 10-10-80 system.  I wrote about it before in a post for couples called Money Management for Couples, and this week’s bootcamp will mostly be a repost and will review some of what we’ve learned the last two weeks.

Mary Hunt's Debt Proof Living philosophy is in many ways similar to Dave Ramsey, with 2 big exceptions: 1. the Contingency Fund (emergency fund) is funded throughout the entire debt repayment process, designating the typical 10% of your income to this purpose, instead of just building up to $1000 and then stopping; 2. a Freedom Account needs to be set up in a separate chequeing account into which monthly installments are made to cover the cost of abnormal expenses such as car repairs or appliance replacement, again throughout the entire debt repayment process and into the future.

A Quick Debt-Proof Living Snapshot

10-10-80

Give 10%; Save 10%; Live on the remaining 80%. It's as easy as that. Out of the 80% comes your sinking fund (Freedom Account according to Debt Proof Living) contributions, as well as your Rapid Debt Repayment Plan funds.

Give

Giving, whether through tithing or donations to various charities or research funds, helps to instill in us a degree of humility and awareness of what it is to be without.

Contingency Fund

Build up a minimum 3 months worth of living expenses in a separate account. Fund this with the 10% of your income that should be going to savings. A better idea would be to save 6 months to a year to be on the safe side. If you have extra monies coming in (i.e. tax returns, cash gifts, or bonuses at work), throw it in here first. This is what will keep you back from the 'edge' and ensure that you won't erase all of your hard work if you are temporarily out of work, have a medical emergency, or have major repairs to cover before insurance kicks in.

The 10% that is designated for savings can be moved around a little bit once you've gotten a fully funded Contingency Fund ready for any emergencies. Once your contingency fund has been topped up to your desired amount, boost your contributions to your Freedom Account so that you have a year's worth of coverage in each of the sub accounts. Next, focus on your Rapid Debt Repayment Plan, and add in your extra 10% so that you accelerate the whole cycle. Finally, begin building an investment portfolio, including paying off your mortgage or saving up a sizeable (conventional mortgages only people!) down payment, funding various retirement and education funds, and add in any 'dream' sub-accounts you may have, to your Freedom Account to begin saving for things like snowmobiles, extended vacations, and additions or renovations to your house!

Freedom Account (Sinking Funds)

Certain things in life are guaranteed. The tax man will come; people will get older, get married, and have babies; cars will break down, so will appliances and toilets; vacations will be needed and our life, auto and health insurance will need to be paid (even if they are charging too much!). If these things don't need to be paid on a monthly basis, most of us forget to budget for them, and very few of us put that money away for when the bill comes due.

Take a look at all of your irregular or abnormal expenses, including car and home repairs and upgrades, gifts, vacations, personal spending, property taxes, auto insurance, and more, and decide on a figure that represents how much you spend (or think you will spend) on these things each year. Then divide that number by how many pay cheques you get each year. Each month, put that money aside in a separate chequeing account, and whenever an expense comes up, write a cheque for it using that account. Keep a ledger documenting each of your debits and credits to the account.

Check out how I keep track on mine here, and download the excel document to get started on yours!

Rapid Debt Repayment Plan

Basically, order your debts from shortest pay-off to longest pay-off, and pay the minimums on everything but the first one, dumping everything extra you can into it. Then, when that debt is paid off, redirect all of that extra money into the next debt. She recommends ordering your debts in order of interest rate (highest to lowest), but says that in our 'instant gratification' society, some may need to see single creditors paid off sooner, so they should stick with the shortest to longest method.

On her website she has a RDRP Manager that you can use to track your debts and your payments and it will show you how many payments you have left and your final pay-off date. I like seeing the reminder, so I joined with the monthly membership, which also gives me access to all sorts of calculators, newsletters, and great tips for saving money.

That is perhaps the biggest thing that (in my mind) separates the Dave Ramsey and Debt-Proof Living methods. Even for non-members, you can join the free Everyday Cheapskate daily column and receive great tips by email on ways to save money. She really teaches frugal living, and shows how you can find that extra money in your income to have your debts paid off sooner.

This Week’s Challenge:

If you have consumer debt you’re working towards paying off, consider using the below calculator or spreadsheet to create a payment schedule and see how tweaking your payments and the order of payoff can save you THOUSANDS of dollars in interest.

Once you’ve compared paying off high interest to smallest amount first, and seen how adding even $100 extra each month can make a BIG difference, start thinking about the ways you can start cutting your spending to help generate that extra cash.

 

Next week we will be discussing some ways you can make small changes in your spending that will have big impact.

 

Resources:

Debt Reduction Calculator Spreadsheet (recommended by Canadian Debt Girl)
Online Debt Calculator

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