Wednesday, June 18, 2008

Quest to be Debt Free – Step 1 Question Pondering

Since my last post, Quest to be Debt Free - Step 1 of the Plan, I have been asked questions regarding the financial soundness of saving money while owing creditors money. So, in this post I plan to address that question. Before proceeding any further, I want to say that I have requested The Total Money Makeover: A Proven Plan for Financial Fitness By Dave Ramsey from my public library and therefore may be able to answer any questions (not only yours, but my own) better as I learn more. Until then, I will do the best I can based on my limited understanding of the plan.

Shortly after I posted my last blog, I received an email from someone close to me (her name is withheld for her privacy) who is also on a financial freedom program. Her plan is different in that you do not save any money until your debt is first paid in full. There may also be other differences, but this is the only difference that has come up at this time. She says:

“…It is different b/c it tells you not to put money in savings if you own a home. Your home equity is your rainy day plan. Reason: you cannot service debt and grow wealth… "All your money is going to interest: house payment interest, car payment interest, credit card interest, student loan interest." This is YOUR wealth going into others' pockets, just how they want it! Americans are spending tomorrow's money today, just how they want it. The banks and credit cards want you to commit your FUTURE earnings to them, that is how they stay in business. Money you haven't even earned yet, is committed to others for years and years and years to come! . . . money in savings earns 2% or so? Your credit cards are over 18% right? Your loans are over 6% right? You cannot service debt and grow wealth. Every penny goes on debt, once debt is eliminated you can grow wealth…”
I think this comment is a great motivator for starting any financial freedom plan, whatever it may be. There is no direct question here, but unless I misunderstood, the question is similar to the comment Alicia posted:

“I don't know how it is possible to start an emergency fund when you (WE)owe on credit cards already... how do you NOT pay that off first to avoid more apr charges... as in would it not be smarter to get rid of that debt first???”
Yes, it would be financially smarter to get rid of debt first, or at least you would think so. You may remember that I my last post I said the following, “It is difficult for me to imagine saving $1000 with an already tight budget. Not only do I need to find the money to save, I need to resist the urge to pay a bill with it.” Here is what is said about Step 1 on Dave’s website:

“An emergency fund is for those unexpected events that are not regularly planned for happening in life - you lose your job, there's an unexpected pregnancy, the car's transmission goes out, or, or, or. Something like this WILL happen. Money magazine says that 78% of us will have a major negative event happen in any given 10-year period of time. So get a rainy-day fund, an umbrella.

This beginning emergency fund will keep life’s little Murphies from turning into new debt while you work off the old debt. If a real emergency happens, you can handle it with your emergency fund.”
The idea is, if something does happen you will have the cash to help you through it. How would you handle a minor emergency if you did not have the cash on hand? I would have no choice but to pull out a credit card, and then I would be doing opposite of what I want to do. I would not be paying off my debt, I would be increasing it. Sure I could use my home equity, assuming I have any; however, home equity is not liquid. Home equity is extracted via loans creating more debt.

Numerous financial freedom programs exist because what works for one does not work for all. Dave’s plan is not the most mathematically correct plan out there but it is a great starting point. Depending on your individual financial situation, you may end up paying out more in interest in the long run by following Dave’s plan; however, the end result is the same, you are debt free. In addition, as you progress through the plan, you can always adjust your plan and do what is best for you at the time keeping one rule in mind, “owe no one”. The reason Dave’s plan is successful is because it psychologically motivates you to follow through. I will get into this further when I am set to proceed to step two; but if you can't wait – you can always jump ahead of my blog and research the plan on your own. I have provided a few links throughout my blog history and a query search will provide many more resources.

1 comment:

dmoms said...

okay, that makes total sense. I get it. Now, to do it.