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Photo by amathal at deviantART

Photo by amathal at deviantART

The topic of debt reduction is multifaceted, but when I think back to what was the most basic concept that served as a foundation for financial health, it has to be the household budget. There are many rules for budgets, and if I go into all of them in this post it will get confusing. So for today, I just want to address the concept of the Zero-Based Budget.

The Zero-Based Budget
In a nutshell, the zero-based budget is a budget that begins with how much money is coming in, and works backwards, paying bills by priority, until we reach zero.

The zero-based budget ensures that every single dollar that comes into the household is put to its best use. Because budgets are highly individualized, I’m going to give you an overly simplistic example to illustrate the basic concept, and then you can tweak it to fit your own household.

Say the Right-Clicks are paid twice a month, $1000 on the first of the month, and $1000 on the 15th of the month. What I am going to do is figure out all of the things we are going to need to spend money on between the time we receive this first check for $1000, and the next one that is due on the 15th of the month. This will be our household budget, December 1-15.

Let’s say our semi-fixed “need” expenses are as follows:

Expenses Date Due Amount Due
Car Insurance December 5 $100
Gas Bill December 10 $40
Electric Bill December 5 $150
Groceries (Enough for 2 weeks) $200
Mortgage* Due January 1* $400
Total $890

So, after paying all of our required expenses, we’ve got a total of $890, which leaves us $110 to play around with. We can use this money for a variety of things, such as pocket money, savings, gifts, or what have you. This is where your own priorities come in. Do you want to put $110 towards your beginner emergency fund (yes!)? Or will you need some of that for Christmas? (Probably.) What about putting extra money on debt (aka the “debt snowball,” which I will talk about later.) How you make these choices is completely up to you, but as you pay more and more attention to where your money is going, you might just find that you’re making better choices for yourself and your family.

*In this hypothetical, as is probably the case in most real budgets, the mortgage is due at the first of the month, but the amount of the mortgage is large enough that you have to allow for it in both budgets. Here, we’re taking out one half to save for the payment later in the month.

Photo by rosieelizabeth at deviantART

When I was in graduate school, I had a low income and was living in a fairly expensive area. I had never been good at cutting things out of my budget in order to live within my means. What am I even talking about? Like I even had a budget! Hah! No, what I had was a low income, expensive tastes, and a disturbingly large credit limit. And so, while I wasn’t exactly living “high on the hog,” whatever that means, I definitely wasn’t living within my means. I think I was pretty convinced that living within my means was impossible, in fact.

So naturally, one day I found myself with a ton of credit card debt that I had to be paid off. I felt pretty desperate and pretty alone in the mess I had created. Though I never missed a payment on a credit card, and never faced foreclosure, for me, having debts that totaled almost as much as I would make in an entire year–with no real career job prospects–was plenty terrifying.

And so, one day I did what I always do when what I’ve been doing isn’t working anymore, whether it is with alcohol, drugs, food, money, or whatever substance I happen to be using at the moment: I hit bottom. And I embarked upon a pretty radical debt reduction program, with help from some key concepts and support groups, and began the process of slowly climbing my way back into financial sanity. Today, about 5 years later, I am consumer debt free–yes, this includes cars–with a healthy emergency fund and even a 529 account started for my son’s college education. I still have a way to go to make my personal finance picture exactly what I want it to be, but if you had told me five years ago that any of this was possible, I would have thought you were crazy.

So, let’s look at what I did. I am going to focus on the steps I took before I met Mr. Right-Click, because that was the period of my most dramatic debt reduction on the least amount of income. I did not pay off all of my credit card debt until shortly before marriage, but I did manage to pay off over $10,000.00 when I was making less than $30K a year. And here are first steps I followed (and recommend) to get out of debt.

  1. Read The Total Money Makeover by Dave Ramsey. This book/program was a lifesaver for me. If you are not already familiar with the Dave Ramsey program, it is a hardcore, no-punches-pulled approach to getting out of debt and living “like no one else.” And you know it has to be good, if I am recommending a book by an evangelical Christian and a Republican. I quickly learned to bite my tongue through all the references to God and the gratuitous Biblical citations–I recommend this program because it is just the thing when you need to give yourself a jump start into acting like a sane person when it comes to money. When you first read it, you might think it’s too hardcore for you. That’s OK. You only have to ease into it. There was a time when I was a full-on Dave Ramsey Bible Thumper, a real strict constructionist, but now there are a few of finer points upon which I disagree with him (these have mostly to do with real estate, but we will discuss this later). Point is, if you just allow yourself to consider thinking about money and debt in a new way, you will get yourself on the right path even when you don’t follow his every word to the letter.
  2. Start listening to Dave’s radio show, if it is available in your area. If not, download a free podcast to listen to on your ipod. Yes, you will have to hear about God now and then, but it will inspire you to keep on track each day. Plus, you won’t feel alone. Because, as is the case with AA, there is always somebody who is worse off than you who is fighting the good fight, and there is always a success story to inspire you to keep going. Also, there will inevitably be situations that come up that leave you in a quandry as to how to handle them–these kinds of questions are answered every day on Dave’s show.
  3. Commit to having a written, zero-based budget for your household every month. This must actually be on paper (or on an excel spreadsheet, as is the case in the Right-Click household), and you must do it even if your income is fluctuating because of self-employment. Please click here to learn an easy way to set up a zero-based budget for your household. If you are married, you should be working on the budget with your spouse, or have one spouse do it and then the other one reads it and approves it. It needs to be a goal that both partners are working towards. The main rule is that no money gets spent in your household without being on that budget sheet, and that the budget is something that you are looking at each month, keeping up with, to make sure you’re staying on the road to financial peace.
  4. Cut up/destroy all credit cards. Yes. All of them. You can keep a debit card, of course, but nothing attached to a credit line. I don’t care if you’re getting “points” on something. If you have a credit card balance that you cannot afford to pay off now, in its entirety, then you are not going to be making any money off those stupid “points.” There are always those people (my parents, mother-in-law, among others) who pay off their balances in full each month and get free airline miles, I know. But if you need a hardcore debt reduction plan, guess what? You’re not one of those people. So cut them up. You don’t have to cancel the accounts (yet), but you do have to cut all of them up now. Sorry.
  5. Related to last rule, commit to using cash (literally, money made out of paper) whenever possible. But you need to commit to paying for as many things as possible with cash. And I mean that literally–whenever you can get yourself to hand over actual paper money, the better. The reason for this is that it is more psychologically traumatic to hand over paper money for some reason than it is to use a debit card, even when money is coming straight out of your account, and there have apparently been studies done that show that you spend less when using cash because of this. No, I don’t have a source. Just trust me. Using cash also gives you a visual representation of how much money you have left in your budget for whatever category (food, clothes, etc.), which leads me to the next rule. Last, but not least, you can sometimes get deals on things if you pay in cash. Mr. Right-Click is much better than I am about negotiating this type of thing. But it’s definitely true, particularly on big purchases.
  6. Use an envelope system for organizing your budget categories. This one will draw objections from many people, but getting out of debt is rarely stylish. What you do here is that you go to the bank once a month and get out enough cash to pay for all of your different budget categories in cash. This won’t work for everything–you can’t just pay your mortgage in cash, probably. But you can pay in cash for a bunch of things. Examples of envelopes we use include: “grocery,” “baby supplies,” “date night,” “pocket money,” etc. When the money from an envelope is gone, you’re done for the month in that category. This system keeps you honest. Click here to read my guide to setting up your own envelope system.
  7. Start looking at your house for things to sell on ebay and/or in a yard sale. Or “tag sale,” if you’re from New England. You would be surprised how many things you can turn into cash with a digital camera and an ebay account. Did I tell you I made $1500 by selling off a fugly set of china (piece by piece, of course, since the sum of its parts is worth more than the set) that I inherited on ebay. Please don’t tell my grandfather. But yeah. Stuff was sitting in a closet, wrapped in newspaper, and I converted it into CASH MONEY. Big items that are tough to ship (furniture, cribs, sports equipment) can be sold on your local craigslist, or at a yard sale. You can also donate for a tax write-off, but if you’re really hurting this is rarely of much consolation. Also, if you have a bunch of CDs, DVDs, and/or books that you’re done with, consider selling them on amazon. Click here to consult my guide to selling on Amazon, or if eBay selling is more your speed, please click here to read my updated tips for maximizing eBay profits.
  8. Check into reduced prices for utilities. If your income is below a certain level, you may qualify for reduced rates for your phone and other utilities. I got my landline phone for about $15 during most of graduate school, and received 10% off my Edison bill. Check with your service providers for information on this. Also, with cable services, a lot of times you can get them to lower the rate if you call and tell them you’re thinking of switching to another company or to DirecTV. You have to be convincing on this point. As far as switching to VoIP technology (e.g. Vonage), this will save you money but you will sacrifice quality, so I would not recommend it. Many people like these services, but I am not one of them. Consider getting rid of your landline and using only a cell phone, if you don’t already do this.

Good luck!

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