frugal underground

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I have had the goal of being debt-free for a long time. I frequently state that I want to have the house paid off by the time I’m 30 (I’m 25 right now, so that’s asking a lot). Once the house is paid off, that puts us at mostly debt-free; our other current debts are student loans (at a higher interest rate than the house, for pity’s sake!) and a 0% car loan. Here’s what I’ve done so far and what I’m planning to do in the next few years.

Our current state of affairs

When my husband, Daniel, graduated from college, we had about $40k in student loans. We consolidated them all together in 2001 to get a better interest rate; it was both good and bad timing. The interest rates were just starting to plummet but the government hadn’t started lowering the official rates very aggressively yet. Hindsight being 20/20, we should have waited just a couple of months for our one-time consolidation; if we had, we’d be paying less interest today. As it is, we’re paying 5.99% interest, which isn’t hideous, but it’s certainly not what it could have been.

We’ve been making a concerted effort to pay off those student loans. Ever since Daniel became employed at a good job (two weeks after he graduated in June of 2001), we’ve paid slightly more than the minimum each month and put bonuses and other “extra” money on the loans. We’ve averaged about $8000 over the minimum each year, which is great because mostly it was unmissed money (like the bonuses; we weren’t counting on them, and hadn’t pre-spent them, so we were able to chunk them onto the loans without much pain). At this point, we’ve paid down the loans to a little under $14k.

In August of 2002, we bought both a new house and a new car. The house is a fairly standard subdivision house, but we intentionally kept it small (1317 square feet) since there are just two of us. We wanted three bedrooms for future needs (and we’re using the extra two as an office—I’m sitting in it writing this—and a guest room/my sister’s room—she’s lived with us since last summer) but they didn’t need to be big. Our mortgage came out at about $140k, which included an appliance allowance. It was a 30-year fixed at 6.5%. Because we didn’t have a 20% down payment, we had a PMI payment of $109/month. We paid a bit extra on the house each month.

Probably it wasn’t the greatest idea to buy both the house and the car in the same month, but we’d been struggling with having one car and two jobs. We went to the Saturn dealership and found a car that made pretty good sense. Saturn has a 30-day money back return policy, and this car had been returned when its new owner lost his job. Bummer for him, definitely, but it knocked several thousand off the cost of a just-like-new car. The dealership was also offering 0% financing at that point, so we bit. The car cost us right around $15k. We’ve paid the minimum payment on that loan because at 0%, it makes much more sense to put our money against the other debts.

In the spring of 2004, interest rates had dropped so much that we decided to take our income tax return and use it to pay closing costs on a mortgage refinance. That made a huge difference. Because the interest rates were a full 2% lower, we were able to go with a 15-year fixed at 4.5% and the minimum payment only went up about a hundred dollars each month (which we’d been paying in extra payments anyway). Since the refinance made our house interest rate lower than our student loan interest rate, we opted to put all the extra payments onto the student loans. We did put a good chunk of money onto the mortgage after we sold some stock, the goal there being to get rid of PMI (which dropped to $54/month, but still!). At this point it looks like we’ll hit official 20% equity in December.

Our future plans

These are the specific steps we are taking to get to “debt-free” (they are also the steps we recommend to anyone who asks us):

• Pay down high interest debt first. After covering minimum payments, we’re going to hit the student loans with all of the money we have earmarked “debt reduction” because they are the most costly (highest interest) loans. If we had credit card debt and it was at a higher interest rate, we’d kill that first. As soon as our student loans are payed off, we’ll roll the full amount of the payments (minimum payments + extra payments) onto the house—the next highest-interest loan. Realistically, our car will find itself payed off just through minimum payments well before all higher-interest loans are payed off.
• Make as many extra payments as possible. This is probably the most common advice out there, but it works. It’s how we’ve been able to make as much progress as we have on our debts. This includes both regular monthly payments (we budget to pay extra) and one-time extra payments. You know those terribly boring people who say that if they won some money, they’d use it to pay bills? Those people are our heros. Contrary to what it might sound like, we do spend money on fun (and sometimes expensive) things, but that money is usually budgeted, not a surprise. Surprise windfalls go to debt and will continue to do so. Realisitically, we need to make even more extra payments if I want to pay off my home in less than 5 more years.
• Seek out additional streams of income. Any time we can increase our income without considerably increasing time worked or stress levels, that’s a great and fabulous thing. I am constantly seeking out ways to do that, both through traditional methods, like stock investing, and more unusual ways, like blogging. The goal really is “multiple streams of income” that will keep bringing in money while I pursue new ideas.
• Keep cost-of-living stable. It is a fact of American society that when the income goes up, so do household expenses. It is an important goal of ours to be abnormal in this regard. We have a reasonable expectation that Daniel will receive a “market-based salary adjustment” (amount unknown, but it will be in the upward direction) in the next couple of months. If this does happen, we are going to run the extra through our minimum budget (percentages for tithe, offering, savings, and our respective fun money) and then everything else will go to debt repayment. (Don’t be disturbed by the presence of “fun money”—it’s a very small percentage and the only money that either of us can spend without the approval of the other). The point is that we will not be using any income increase to make extra purchases or afford a bigger house. Which brings me to…
• Avoid too much house. This is one of the single best things we’ve done. Real estate prices are highly inflated in most areas of the country, and lenders are disturbingly eager to qualify people for huge loans that they can’t realistically afford—that, or interest-only monsters. Those really scare me. We are operating under the idea that if you can’t comfortably afford a monthly payment on a standard loan, you should probably be looking at a smaller home or hold off on purchasing until your financial position is a little better. We are in a small house. We will stay in this small house for a long time, or if we don’t for some reason, we won’t be taking on extra debt in the process.

So that’s basically my background and the specific strategy that is going to help us become debt free. (Congratulations for making it through this rather unexpectedly lengthy state-of-the-debt post.) How about you? What are your biggest successes and resolutions in this area? When do you plan on being debt-free?

Related Link: Low Interest Credit Card will prevent you from getting into debt.

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This entry was posted on Sunday, September 18th, 2005 at 3:50 pm and is tagged General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.