In our August 2022 column, we introduced a few specific methods of sticking to a budget. We
will review some of those methods in more detail in this and the next few columns.
Financial messes usually occur when cash flow is tight. Although this can be from a job loss,
health crisis, or over spending, the most common scenario is multiple debt accounts. In our
office, we have worked on cases with as many as 15 to 20 credit card accounts for one family.
As the credit card balances increase, so does the minimum payment. As the minimum payment
increases, cash flow becomes tighter. This can easily become a vicious cycle in which more
credit card debt is needed to fund monthly expenses, which further increases the monthly
minimum payments. Eventually, something has to give.
The first step in turning a situation like this around is setting a reasonable budget. Within the
budget, a proven technique is to work on saving a small emergency fund ($1,000 to $1,500) and
then list the debts by balance, starting with the smallest balance. Then, using all the money that
can possibly be freed up in the budget, apply all extra money to the smallest balance first. On all
other accounts, pay only the minimum balance.
This technique accomplishes several important goals. First, the small emergency savings will
create a buffer between you and life, so that new credit card debt can be minimized. Second,
most folks in this position need to score a psychological win. Paying off even a very small
balance is a win, and working quickly through the first few small balances helps to build
motivation and lay a foundation for success.
Third, this technique frees up cash flow quickly. In many cases, one minimum payment can be
eliminated within 2-3 months. This represents extra cash flow available. Now, let’s say you have
eliminated three minimum payments by paying off three accounts. You’re well on your way to
success, when a crisis occurs. Your plan is to pay $250 on the next smallest balance, and the
minimum payment is only $50. You can take the difference of $200 and apply it toward the
crisis, even if you have to do this for two months. Then, once the crisis is over, you can get back
on track with the technique.
Contrast this with a consolidation loan. Yes, you might end up with a lower overall debt
payment, but the monthly payment doesn’t change. With the technique presented, your total
minimum payments will decrease over time, and you can use the extra cash flow to address
emergencies if needed. That’s not an option with a consolidation loan.
Don’t forget to close debt accounts once they are paid off.
R. Joseph Ritter, Jr. CFP® EA is the Executive Director of Zacchaeus Financial Counseling,
Inc., a 501(c)(3) non-profit organization based in Lake Junaluska, NC which specializes in tax
services and financial counseling and planning for low and middle income households.