Ask a loan advisor or real estate agent what they find satisfying about their career, and many will say how rewarding it is to help people buy their first home. If you ask those same professionals about the biggest challenges for first time home buyers, and they’ll bring up two sticking points:
- Buyers often carry too much debt
- Buyers don’t have enough cash saved for a down payment.
These are two sides of the same coin. If you want to buy your first home, the goal is clear: get rid of debts that create a drag on your ability to save up for a down payment.
Mentally, we all know we shouldn’t spend more than we earn. It’s one of the common sense “rules” that we try to live by, but maybe let slip a little too often. That sweater you bought last week might look good, but it’s a lot less satisfying to own if there’s a nasty credit card balance hanging over your head.
Okay, so now you’re in debt. You wish you hadn’t done it in the first place. No use crying over spilled milk. Instead, move forward and take the necessary steps to reduce your debt. We’re going to change how you manage your money, making it easier to save money for a down payment on a home!
Stop Adding to Your Debt
If you want to get out of debt, the first step is to stop adding to your outstanding balances. One trick I’ve used is to keep only one credit card in my wallet. And, it’s the card with the lowest credit limit. Thus, it’s impossible for me to get into any serious trouble with it. No wild spending sprees are possible. Other cards I have, with higher limits, stay at home in my dresser drawer. Those cards are only there for emergencies. So, leave all but one card at home. After a while, you’ll forget that they're there.
Take an Inventory of Your Spending Habits
If you haven’t already done so, create a list of all the places your money goes every month; including rent, credit cards, utilities, food, car payments, gas, insurance, medical, dental, charity, Starbucks, etc.
Then, split the list into two, separate lists.
The first list includes items that you’ll always have to pay (e.g. utilities). The second list includes debts you can pay off. For example, you’ll always have an electric bill, so that goes on the first list. Since it’s feasible to pay off your Sears credit card, that goes on the second list.
For the second list, reorganize the order of the items either by:
A: Largest account balance (Debt Snowball), or
B: Largest interest rate (Debt Avalanche).
Now you have a clear picture of your debt situation. All the cards are on the table. Pun intended.
Eliminate the Biggest Debts First
The Snowball and Avalanche plans help you take a big chunk out of your debt every month, but they work differently. The Snowball method will help you to rapidly reduce the number of debts you owe, while the Avalanche method will help you do the same, but with less interest and a shorter time frame.
First, make the minimum payment for every bill.
Then, make an extra payment for the one item that is on the top of your list.
Repeat monthly until the item on the top of your list is paid in full.
After you’ve paid off the first item, take the money you were using to pay if off and now apply it to the second item on the list. Knock off each #1 item every month until all balances are paid off in full.
Some people prefer the Snowball method, as they will find themselves encouraged as each bill is eliminated from their budget, but if you can change your thinking, you can do better.
“One of the many reasons people can fall into debt is the difficulty of separating emotional thinking from rational thinking,” says Luke Landes. “The Debt Avalanche helps separate these two methods of thinking, as the best financial decisions are almost always the rational decisions.”
Cutting Expenses and Making the Payment
So, if you are already in debt, how can you expect to pay anything extra to the bill at the top or your list? Just like a well-crafted movie: clever editing. If you spend $100 a week on groceries, try to spend $5 fewer dollars. Do you go to the movies every weekend? Cut that down to two weekends a month and enjoy something from Redbox on the other weekends. Do you buy a latte every day before work? Why not treat yourself to one special beverage each week and try to swallow the company coffee (with a special creamer you bring from home) on the other days?
You get the idea. Whatever you can cut out of your weekly spending, you can add to the payment to the top item on your Snowball or Avalanche list.
Prepare for the Unexpected
Our lives are full of struggles, and certain unplanned expenses will pop up from time to time like car repairs or extra medical bills.
Set aside some money you save from cutting your expenses and stash it into a special savings account that is created just for this purpose. That way when tough times arrive, you’ll be ready.
The emergency fund can be used instead of pulling out your credit card.
Lower Your Interest Rates
Contact your credit card company to see if they can offer you a lower interest rate on your card. If not, shop around for a card with a lower rate and transfer your balance to the new one. See if your bank offers a consolidation loan, where they pay off all of your credit card debts, and you pay them back at a lower interest rate.
Acknowledge Your Progress
Give yourself incremental milestones ($500, $1000, $1500, etc.) and reward yourself with something fun. If this reward costs money, then set aside a little cash each month to save for this very purpose. There is no sense adding to your debt due to your celebration of reducing it. Keep the reward under $100. The emotional significance of reaching a milestone is far more important that the value of the reward. When choosing a reward, put more emphasis it's meaning rather than it's monetary value.
Keep Building That Snowball or Avalanche
The more items you can knock off your list, the more money you’ll have to pay off the remaining debt. With each new milestone, add more money to your savings account. As you eliminate debt, you want to increase your savings and plan for your future (e.g. buying a home).
A Few Extra Tips to Cut Spending
Find Tax Deductions and Credits
Don’t miss out on lucrative tax credits and deductions in our tax code. Be sure to do your research ahead of time, and you could get a larger refund.
Abandon Unused Subscriptions and Memberships
We all have good intentions to fully use that gym membership, read magazines and use that timeshare. If you’re not using these things as much as you thought, consider dropping some, or all, of them. If you aren’t using the gym, there is no reason to keep paying for it. Take up running or walking (free) or buy some used free weights on Craigslist (cheap).
Cut Down Expenses on Hobbies
Before you run out and buy that $300 kayak, ask yourself realistically how often you will use it. Maybe three times each summer? Yes, renting a kayak might be expensive, but compare that the cost of ownership. If the renting a kayak costs $25/hour, you could get in 12 trips in for the same price as buying one without having to store it or lug it around.
Never Pay Full Price
Finding deals won’t be practical for everything, but the truth of the matter is, we can all save a little more here and there by looking for sales, specials, coupons, etc. Yes, it will take more time, but every bit you save here can be used to pay off your debt there. Planning ahead also helps. For example, my local picture frame shop has a sale every six months, usually for 50% off custom frames. I’ll wait a few months for the sale instead of paying full price today.
Don’t Be a Snob
Don’t be "too good" to shop at thrift stores or garage sales to find excellent bargains for you and your family. If you haven’t done so in a while, you’ll be surprised by some of the great things you can get for just pennies on the dollar. You can even find top notch kitchen gear, like La Creuset bakeware, at Ross from time to time!
Final Thoughts: Debt Reduction and Home Buying
The best ways to learn anything new is to follow a system. Conquering debt requires a deliberate approach. But why?
First, good systems are actionable. Whether you chose the Debt Avalanche or Debt Snowball, there’s a clear series of steps in front of you. Stay focused on those steps. Don’t start improvising. You want to pretend this is Music Theory 101, not Jazz 401.
Second, systems make progress measurable. If you know where you’re going (a goal) and how you’re going to get there, you’ll be far more likely to stay on track. As you watch your debts go down, you’ll start feeling more control over your situation. Which leads us to the last point...
Following a system creates a foundation for better habits. Having a financial routine each month reinforces healthier financial behavior. Over time, you’ll spend a lot less energy thinking (worrying) about debt. Instead, staying “disciplined” becomes a lot more automatic (effortless). It’s a liberating feeling.
Tony Mariotti is the founder of RubyOne Mortgage Company. In addition to helping people finance their homes, he is a sought after blogger. His favorite topics are marketing, real estate and finance.
You can find Tony & Ruby Mortgage on Twitter by CLICKING HERE.
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