Gaze toward the top of the financial-guru mountain, and the woman whom you see preaching debt freedom with a megaphone is probably none other than Mary Hunt.
As the author of umpteen financial books (Debt-Proof Living is a fabulous one, as is The Cheapskate Monthly Money Makeover, and there are more coming) and founder of the Debt-Proof Living monthly newsletter, Mary Hunt has watched hundreds (thousands?) of motivated folks dig themselves out from under staggering debts. What sets her apart from all the other financial authors?
She conquered those same staggering debts in her own life.
The Freedom Account isn't Hunt's only contribution to her readers' financial successes. She also devised what she calls the "Rapid Debt Repayment Plan," or "RDRP," for short. The RDRP relies on four rules:
Yes, this should be self-evident. But some folks still need to see it in writing. No debt payoff plan will work — not a one of them — if you continue taking on more debt. If you enjoy futility, however, then keep whipping out the plastic. This financial equivalent of "digging yourself out of a hole" might be just your thing.
So how do you keep from using debt? Simple: Create and stick to a spending plan. Build an emergency fund. Employ a Freedom Account. Use all these when necessary. The combination of those three things, with a dash of discipline and self-control thrown in, should keep the dreaded New Debt at bay.
Think this is only mildly important?
"Unless you are willing to stop adding to your unsecured debts," Hunt writes, "you're really out of luck when it comes to debt-proofing your life."
Most credit cards figure your monthly minimum payment by computing a simple percentage of the outstanding balance (perhaps 2 or 4 percent). If you're paying more toward your debt than you are adding to it via interest, fees, and purchases, then your outstanding balance is declining. And so is your required minimum payment.
Your task is to ignore the declining minimum payment. Keep paying the same amount toward the debt — or more, if possible — month in and month out. After a few months, you're accomplishing exactly what financial pros advise: Always pay more than the minimum.
In this case, "duration until payoff" means:
Grab a piece of paper (or fire up our RDRP Sorter spreadsheet) and list all your debts' current balances. Exclude your home mortgage, if you have one.
Divide each balance by its current payment. The resulting number is that debt's "duration until payoff."
Now rearrange your debts in order of smallest "duration until payoff" to largest. This is the order in which to launch your torpedoes ... and start sinking those debts.
It's yet another occurrence of the popular "snowball" method of debt payoff: When you pay one debt in full, take its monthly payment and add it to the payment of the next debt. When that debt is paid off, take its payment money and add it to the payment of the next debt in your list.
Pretty simple, right?
"All of us who are intimately familiar with overspending know that it is very easy to five-and-ten-dollar ourselves into oblivion," Mary writes in The Cheapskate Monthly Money Makeover. "The good news is that you can five-and-ten-dollar yourself right back to financial health, too."
What's the Big Deal?
"A plan is only as good as your ability to stick with it," Hunt tells us in Debt-Proof Living. "No matter how effective the plan is on a daily basis, if the regimen is outlandish and impractical, you will not stick with it no matter how good it looks on paper."
As we saw in Dave Ramsey's "Debt Snowball" plan, motivation can be the single most important aspect of a debt-paydown strategy. It's for this reason that authors like Mary Hunt suggest paying debts with smaller balances (or payoff times) first. The sooner you see your debts disappearing, the more likely you are to stick with the task at hand. Watching your debts vanish gets you fired-up, and keeps you fired-up. Before you know it, your debt load has lightened significantly.
The RDRP In Action
It might clarify things a bit if we show the RDRP in action. Let's consider a fictional household — we'll call them the Bachs — and watch as they put the RDRP into practice.
It seems that the Bachs are better off than your average U.S. household. They have only $5,000 in debt, not including their mortgage. Of that total, only $1,000 is credit-card debt. Still, they want to get rid of their debts, and they want to use the RDRP to do it. All told, their household liabilities look like this:
As we can see, the Bach family's debts currently require $348 per month in payments. Since we know that the RDRP attacks debts in order of duration (account balance divided by minimum payment), we need to sort their debts by duration, from smallest to largest. Let's do that — or better yet, make a spreadsheet do it! — and see what it looks like. Here goes:
The debts are now sorted from smallest payoff duration to largest. The Bachs are ready to get serious about debt freedom and watch their plan do its thing.
Their auto loan will get attention first, as the payments will retire the loan completely in just 10 months. (As we see above, its payoff duration is 9.8 months.)
During this initial 10-month period, the Bachs should be tracking their debt-paydown progress each month. They could use something like the Debt Tracker spreadsheet to do this, or they could create a simple chart by hand which depicts their decreasing balances. Either way, this is an important step of any debt-paydown plan: You need to track your progress at all times. And keep your progress in front of you!
Even simple charts — pencilled, perhaps, on graph or notebook paper — like this are a great way to fight back during those times when you may get discouraged because your debts aren't vanishing "fast enough." Odds are that you will encounter those times. You must give your plan a chance to work.
So now let's skip ahead 10 months. The auto loan is paid off. Since Mary Hunt's RDRP calls for us to "snowball" our payments, we'll take the auto-loan payment sum of $206 and add it to our next payment on the list. In this case, it is added to the payment for Medical #1. Our RDRP payment for Medical #1 now becomes $240 ($206 plus $34). Thanks to that, its duration is greatly shortened! It'll be gone in just two months, as shown here:
Notice that the total amount of monthly payments doesn't change; the Bachs are still paying $348 toward their debts. Also note that their credit-card debt has declined from $1,000 (at the beginning) to now just $600 (no, I didn't factor for interest, as I wanted to keep this simple!). That means that the Bachs' monthly credit-card statements probably show a required minimum payment that's substantially less than it was when they started. They've ignored that, just as Step #2 of the RDRP advises. They have continued to pay $40 per month toward the plastic.
Two months later, Medical #1 is paid in full. Here's what's left:
The Bachs rolled the payment from now-dispatched Medical #1 in the next debt on the list. In this case, that's Medical #2. As shown above, Medical #2's payment now becomes $308 ($240 plus $68). With that new payment amount, it now has a duration of 1.7 months. So, two months later, the Bachs have:
Only the credit card remains! And, thanks to the snowballed payment of $348, it will be gone after just two more months:
The Bachs are now debt-free except for their mortgage. Obviously, this was a really simplistic example. In the real world, interest charges would accrue on balances, thus extending payment durations. However, in the real world, the Bachs would also be expected to tighten their budget, work longer hours, sell stuff, and otherwise "find" more money to put toward their debts! I didn't allow for any of that here, as we can see. The intent was purely to detail Mary Hunt's RDRP process — to show how it works by creating a series of charts.